Shifting Shores: FDI Relocations and Political Risk A report from the Multilateral Investment Guarantee Agency Copyrights and Credits © 2024 Multilateral Investment Guarantee Agency (MIGA) 1818 H Street NW, Washington, DC 20433 http://www.miga.org/ This work is a product of staff of the Multilateral Investment Guarantee Agency (MIGA) with external contributions. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of MIGA concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The contents of this work are intended for general informational purposes only and are not intended to constitute legal, securities, or investment advice, an opinion regarding the appropriateness of any investment, or a solicitation of any type. Additionally, the information is provided on a strictly “as is” basis, without any assurance or representation of any kind. Nothing herein shall constitute or be construed or considered to be a limitation upon or waiver of the privileges and immunities of the Multilateral Investment Guarantee Agency, all of which are specifically reserved. Rights and Permissions The material in this work is subject to copyright. Because MIGA encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given and all further permissions that may be required for such use (as noted herein) are acquired. MIGA does not warrant that the SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK content contained in this work will not infringe on the rights of third parties, and accepts no responsibility or liability in this regard. The risk of claims resulting from such infringement rests solely with you. If you wish to reuse a component of the work, it is your responsibility to determine whether permission is needed for that reuse and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to MIGA’s Legal Affairs and Claims Group (Attn: Chief Counsel, Operations & Policy), 1818 H Street NW, U12-1204, Washington, DC 20433. Attribution Please cite the work as follows: Moritz Nebe, Persephone Economou, Leo Abruzzese. 2024. Shifting Shores: FDI Relocations and Political Risk. Washington, DC: MIGA, World Bank. This is an informal staff report. It does not reflect the views of MIGA or its Board of Executive Directors. This report is intended for discussion. Photographs Ray Witlin/World Bank, Curt Carnemark/World Bank, Yayo López/World Bank, John Hogg/World Bank, Gerardo Pesantez/World Bank, Dana Smillie/World Bank, Arne Hoel/World Bank, Gerhard Jörén/World Bank, Kubat Sydykov/World Bank, Curt Carnemark/World Bank, Jonathan Ernst/World Bank, Dana Smillie/World Bank, Dominic Chavez/World Bank, Eric Miller/World Bank, Nick van Praag/World Bank, Simone D. McCourtie/World Bank ii © MIGA, 2024 Acknowledgments This report was prepared under the overall guidance of Ethiopis Tafara, Vice President and Chief Finance, Risk, Legal and Sustainability Officer at MIGA, and Sebnem Erol Madan, Director of the Economics and Sustainability Group at MIGA. The principal authors were Moritz Nebe, Persephone Economou and Leo Abruzzese. We thank D. Gomez Altamirano, who prepared the brief on the World Trade Organization’s investment facilitation agreement; Damien Boucher, who provided analysis of FDI stocks; Shiho Nakano, who provided data support at various stages of the project; Jessica Wade, who contributed to the political risk analysis in chapter 3; and Alasdair Ross, who supported the literature review and the survey process. The report team drew on resources throughout the World Bank Group, and we thank Carlos Arteta, Amat Adarov, Lucio Castro, Alen Mulabdic, Sylvia Solf, Haley Marie Pallan, Daria Taglioni, and Hoda Atia Moustafa for sharing their research and insights. Special thanks to Arlan Brucal for his analysis of greenfield FDI datasets, which was invaluable for this report. We are also grateful for the support of Paul Heaney of the Berne Union. We extend our sincerest thanks to the World Association of Investment Promotion Agencies (WAIPA), which administered MIGA’s survey on near-shoring and friend-shoring, and especially to Andreas Hora. We thank peer reviewers from within the World Bank Group, including Ayhan Kose, Mona Haddad, Asya Akhlaque, Dilip Ratha, Dilek Aykut, Ivan Anton Nimac, Harald Jedlicka, Mauricio Alejandro Latorre, Eduardo Sandoval, Heidi Stensland, Jessica Wade and Eugeniu Croitor. We also thank peer reviewers from outside the Bank, including Karl Sauvant, Neil Shearing, Ismail Ersahin and Richard Bolwijn. Thanks to Jane Sunderland for proofreading the report, Mike Kenny for layout and design, and Marcus Krackowizer for building a data tool to analyze the survey results. Thanks to Elizabeth Howton for providing guidance on communications. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK iii © MIGA, 2024 Contents Abbreviations vii Foreword 1 Executive summary 3 Chapter 1 Trends in foreign direct investment in developing countries 9 Key messages 10 Overview 11 Global FDI trends 13 Why FDI matters and how it has shifted 16 Most developing country FDI goes to upper-middle-income economies and is highly concentrated 18 Big FDI increases in smaller economies 20 Greenfield investment has been rising of late 22 Sectoral trends show a steady rise in nonmanufacturing FDI in developing countries, led by IT, 23 construction, and power investment FDI distinctions between low-income and middle-income countries 24 Motor vehicle and computer FDI have been important to developing countries 26 Reinvestment of earnings has been increasing in developing countries 27 Spotlight: Historical and geographic shifts in FDI stocks 28 Conclusion 32 Chapter 2 Near-shoring, friend-shoring, reshoring, and FDI relocations 34 Key messages 35 Introduction 36 What can we learn from the data? 36 Trade, FDI relocations, and intermediate countries 37 The shifting FDI landscape through the eyes of investment promotion agencies 42 Russia’s invasion of Ukraine is number one risk, but supply chain disruptions also rank high 43 Outlook for FDI 45 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Outlook for friend-shoring, near-shoring, and reshoring 47 Impacts on FDI relocations 48 Conclusion 56 Chapter 3 Political risk insurance in an age of uncertainty 58 Key messages 59 Overview 60 Political risks and constraints to foreign direct investment 61 Recent trends in political risk insurance 66 Industry trends 71 Claims and recoveries 72 Conclusion 74 References 76 Appendix 1 IPA CEO Survey of Trends and Emerging Patterns in Foreign Direct Investment (FDI) 82 Appendix 2 Literature review and supplemental data analysis 90 Geopolitics and FDI relocations—a literature review 91 Winners and losers 94 FDI between the United States and China 98 iv © MIGA, 2024 Boxes Box 1.1 Understanding FDI and its components 15 Box 1.2 Investment Facilitation for Development Agreement: An opportunity to catalyze investment climate reforms 17 Box 1.3 FDI in challenging environments: Mozambique 22 Box 1.4 FDI in services and clean energy are rising in developing countries 23 Box 1.5 China’s growing presence as an outward FDI investor 31 Box 2.1 Is US FDI relocating to Mexico? 40 Box 2.2 Friend-shoring in India 41 Box 2.3 The MIGA-WAIPA Survey 42 Box 2.4 Ranking investment risks 43 Box 2.5 Friend-shoring opportunities: The views of foreign investors in Bangladesh 49 Box 3.1 The structure of the political risk insurance industry 67 Box 3.2 Carbon credits and political risk insurance 69 Box 3.3 Fair and equitable treatment in bilateral investment treaties and political risk insurance 70 Box AP2.1 The relationship between FDI and international trade 94 Figures Figure ES.1 FDI inflows into developing countries, $ billions 5 Figure ES.2 Impact of friend-shoring on FDI relocations 6 Figure ES.3 Ratio of PRI issuance to FDI flows into developing countries, 2005–23 7 Figure 1.1 FDI inflows into developing countries, 2010–23 11 Figure 1.2 Global FDI inflows as a percent of nominal GDP, 1998–2023 13 Figure 1.3 FDI inflows to developing and high-income countries, 2014–18 vs. 2019–23 14 Figure 1.4 FDI into developing countries as a percent of all FDI, 2000–2023 14 Figure 1.5 FDI inflows into developing countries, excluding China, 2010–23 16 Figure 1.6 FDI inflows into developing countries by income group, 2014–18 vs. 2019–23 18 Figure 1.7 FDI inflows into developing countries, 2019–23 19 Figure 1.8 Selected developing countries with large FDI increases, 2014–18 vs. 2019–23 20 Figure 1.9 FDI inflows into low-income and vulnerable countries, 2013–23 21 Figure 1.10 FDI inflows into low-income and vulnerable countries, 2013–23 21 Figure 1.11 Value of announcements of greenfield FDI in developing countries 22 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Figure 1.12 Announced greenfield FDI by sector, developing countries, 2010–23 24 Figure 1.13 Announced greenfield FDI by sector, low-income countries, 2014–23 25 Figure 1.14 Announced greenfield FDI by sector, middle-income countries, 2014–23 25 Figure 1.15 Motor vehicle FDI, greenfield announcements, developing countries, 2010–23 26 Figure 1.16 Greenfield FDI announcements in computing infrastructure, data processing and hosting, 26 developing countries, 2010–23 Figure 1.17 Reinvested earnings in developing countries, 2011–22 27 Figure 1.18 Countries in which European Union has more than 10 percent of FDI stock, 2009 and 2022 29 Figure 1.19 Countries in which United States has more than 10 percent of FDI stock, 2009 and 2022 30 Figure 1.20 Countries in which China has more than 10 percent of FDI stock, 2009 and 2022 31 Figure 2.1 US merchandise imports from China and Asian countries 37 Figure 2.2 Value and number of announced greenfield FDI projects from China to selected manufacturing hubs 38 Figure 2.3 Value of announced greenfield FDI projects from China to other countries, 2014–23 39 Figure B2.1.1 US FDI flows to Mexico, 2014–18 vs. 2019–23 40 Figure B2.1.2 US mergers and acquisitions in Mexico, 2018–23 40 Figure 2.4 Geopolitical and economic risks of most concern to IPAs, 2022–23 and 2024–26 44 v © MIGA, 2024 Figure 2.5 Expected change in FDI, 2024–26, compared with prior three years 44 Figure 2.6 Outlook for FDI by sector, developing countries, 2024–26 45 Figure 2.7 Importance of friend-shoring to foreign investors, 2024–26 47 Figure 2.8 Importance of near-shoring to foreign investors, 2024–26 47 Figure 2.9 Impact of friend-shoring on FDI relocations 48 Figure B2.5.1 How well is Bangladesh positioned to take advantage of friend-shoring? 49 Figure 2.10 Factors driving friend-shoring 50 Figure 2.11 Sectors most likely to be affected by friend-shoring during the next three years 51 Figure 2.12 Impact of near-shoring on FDI relocations 52 Figure 2.13 Factors driving near-shoring 52 Figure 2.14 Impact of reshoring on FDI relocations 53 Figure 2.15 Factors driving reshoring 54 Figure 2.16 Expected shift from imports to domestic production in priority areas, next three years 54 Figure 2.17 Sectors in which FDI is expected to substitute for imports 55 Figure 3.1 Ranking of political risks by importance to foreign investors 63 Figure 3.2 Constraints to FDI in 2024 64 Figure 3.3 Constraints to FDI over the next three years compared with the previous three years 65 Figure 3.4 FDI flows to EMDEs and PRI investment cover, 2005–23 66 Figure 3.5 PRI and medium- and long-term export credit insurance 68 Figure 3.6 PRI cover provided by Berne Union and Prague Club members based in developing countries, 2019–23 68 Figure 3.7 Ratio of PRI issuance to FDI flows into developing countries, 2005–23 69 Figure 3.8 Ratio of PRI issuance to FDI flows into low-income, lower-middle-income, and 70 upper-middle-income countries, 2005–23 Figure 3.9 Percent of PRI issuance by type of Berne Union member, 2005–23 71 Figure 3.10 Claims paid by Berne Union members, 2005–23 72 Figure 3.11 Claims paid by Berne Union members by type of political risk 72 Figure 3.12 Ratio of claims to maximum liability for Berne Union members 73 Figure AP2.1 FDI between geographically and geopolitically close countries, 2003–21 92 Figure AP2.2 World Bank FDI entry and screening tracker—FDI measures by type 96 Figure AP2.3 United States–China FDI flows, 2003–23 98 Figure AP2.4 United States–China international trade flows, 2008–23 99 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Figure AP2.5 European Union–China FDI flows, 2013–17 vs. 2018–22 99 Tables Table B2.3.1 IPAs’ contacts with investors, per MIGA-WAIPA Survey 42 Table B2.4.1 Geopolitical and economic risks, 2022–23, per MIGA-WAIPA Survey 43 Table B2.4.2 Geopolitical and economic risks, 2024–26, per MIGA-WAIPA Survey 43 Table B2.5.1 What are the primary factors that place Bangladesh in a favorable or somewhat favorable position 49 to capitalize on friend-shoring? Table B2.5.2 What measures would promote friend-shoring in Bangladesh? 49 vi © MIGA, 2024 Abbreviations BU Berne Union ECA export credit agency EMDEs emerging markets and developing economies EU28 European Union (for years including the United Kingdom) FDI foreign direct investment GDP gross domestic product ICT information and communication technology IDA International Development Association IFDA Investment Facilitation for Development Agreement IMF International Monetary Fund IPA investment promotion agency ISIC International Standard Industrial Classification of All Economic Activities LDC least-developed country M&A mergers and acquisitions MIGA Multilateral Investment Guarantee Agency OECD Organisation for Economic Co-operation and Development PRI political risk insurance SAFTA South Asia Free Trade Agreement SPE special purpose entity UNCTAD United Nations Trade and Development WAIPA World Association of Investment Promotion Agencies WDI World Development Indicators (database) WTO World Trade Organization All dollar amounts are US dollars unless otherwise indicated. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK vii © MIGA, 2024 Foreword Foreign direct investment (FDI) is a cornerstone of development. Lured by improving business climates and reinforced by an open trading system, FDI has helped lift hundreds of millions of people out of poverty. But the cascading crises, increasing risks, and slower growth the world is facing today have changed the landscape. FDI into developing countries has been on a downward slope, dropping from just under 3 percent of GDP in the early 2010s to around 1.6 percent in the 2020s. Although the decline is less pronounced when China, historically an FDI powerhouse, is excluded, the trend is still downward. The slump comes just when the need for private capital in developing countries is greatest—both to jump-start development after the shock of COVID and the sovereign debt it left behind, and to finance the green energy transition. FDI is not just in shorter supply; it is also relocating to new destinations as friend-shoring and near-shoring emerge. These shifts are an outgrowth of geopolitical fragmentation—the redirecting of investment and supply chains based on proximity and geopolitical affiliations. A new survey of national investment promotion agencies conducted for this report shows the potential for disruption: more than 80 percent of these agencies believe FDI relocations will have an important impact on their countries in the coming years. Indeed, some Western companies are already redeploying their capital to create the resilience that can come from near-shoring and friend- shoring. Chinese companies, for their part, are sending record sums of FDI into third-country SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK manufacturing hubs like Malaysia and Vietnam that are thought to have more assured access to the US market. Countries at risk of losing FDI can turn to a remedy that has worked for decades: foster an investment-positive business climate. This will be even more important in an era of rising geopolitical stress and the near-shoring and friend-shoring that come with it. Political risk insurance (PRI) can partially address the investor concerns that underlie this disruptive new landscape. Yet the share of FDI covered by PRI remains small and is declining, as this report shows. Many of the biggest risks are found in low-income countries as they emerge from the pandemic with debt challenges and limited financial reserves. This has coincided with an increase in political instability, fragility, violence, and conflict. PRI cover is higher in lower-income countries than elsewhere in the developing world, but much more can be done to make investors aware of how political risks can be mitigated and insured. Providers of PRI would do well to bring to market new products that are better tailored to investors’ evolving needs. This is where MIGA and the World Bank Group’s new guarantee platform come in. MIGA encourages FDI in developing countries by supporting impactful projects through guarantees 1 © MIGA, 2024 Foreword that insure against political risk and protect lenders against defaults. MIGA began hosting the new World Bank Group guarantee platform in July 2024, with the aim of consolidating guarantee products that had been scattered across the Bank Group’s different institutions. We are making guarantees more accessible for clients by simplifying our offerings, processing guarantees faster, and developing new and innovative products to support private-sector investments and lending. Our goal for the platform is ambitious—to issue $20 billion in guarantees annually by 2030. Indeed, at a time when FDI needs a boost, the guarantee platform will provide comprehensive risk mitigation solutions for investors looking to spread and deepen their reach. The platform will help emerging markets climb the development ladder by enabling new capital to flow to countries that are ready to use it. We hope this report contributes to a better understanding of the transformation in FDI that is under way, and the roles that political fragmentation and political risk are playing. Despite these risks, opportunities are everywhere—in technology, in manufacturing, in financial services and especially in renewable energy projects and other climate-smart investments that will be needed to improve lives and protect the planet. It is up to each of us to seize these opportunities. Ethiopis Tafara Vice President & Chief Finance, Risk, Legal and Sustainability Officer, MIGA SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 2 © MIGA, 2024 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 3 © MIGA, 2024 Executive summary Executive summary Foreign direct investment (FDI) has powered prosperity in developing countries for decades. Yet FDI, once a reliable contributor to economic growth, a conduit for the transfer of technology and innovation, and a link to domestic and international markets, has slowed in recent years as shocks have multiplied. Global commercial competition, supply chain disruptions during and after the pandemic, less efficient transportation and shipping routes due to conflicts, and policies aimed at encouraging investment at home are increasingly shaping the flow of FDI. A half century of global economic integration, driven by trade and FDI and the search for markets, natural resources, and low labor and input costs, is shifting to a more uncertain investment environment. This new world of FDI increasingly is defined by near-shoring, friend-shoring, and reshoring—each a way to gain greater control and ensure the resilience of supply chains and access to markets. As a result, FDI is relocating, with the shifts influenced by factors determined by geopolitical proximity, in addition to traditional location-specific determinants. Consequently, some emerging markets and developing countries (EMDEs) may attract less FDI, while others stand to benefit from their geopolitical or trade alliances. Although anecdotal reports of FDI relocation in specific countries are common, the scope of this trend remains uncertain. Questions such as the extent of FDI relocations, the permanence of these trends, and which countries stand to benefit the most are yet to be fully answered. To help understand these developments and the challenges they raise, this report presents new evidence based on the findings of a survey of investment promotion agencies, the national organizations that shepherd billions of dollars of FDI through the global economy each year. We also examine FDI shifts through third countries for geopolitical reasons. The conclusions suggest that near- shoring and friend-shoring-driven relocations are increasingly shaping the FDI landscape. Chapter 1 This chapter analyzes recent trends in FDI, mainly in developing countries. FDI into EMDEs has been on a broadly downward trend since the recovery from the global financial crisis of 2008–09, SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK interrupted only by a post-COVID-19-pandemic investment surge in 2021 and record FDI flows into China that year. For the five years from 2019 to 2023, FDI inflows into developing countries 1.7% The average totaled $2.8 trillion (in nominal terms), down 3 percent compared with the previous five years. Because developing country economies’ gross domestic product (GDP) grew during this period, FDI inflows as a share of nominal GDP fell from 2.1 percent (average for 2014–18) to 1.7 percent FDI-to-GDP ratio (2019–23), the first sustained FDI-to-GDP ratio below 2 percent since the mid-1990s. for developing countries for the After the collapse during the pandemic and the rebound in 2021, FDI inflows into developing period 2019–23, countries fell again in 2022, by 19 percent, and by a further 30 percent in 2023. The main driver the lowest in decades of the 2023 decline was a nearly 80 percent drop year-on-year in FDI inflows into China, the result of both slowing GDP growth in the country and investors’ concerns that China’s business environment is becoming more challenging. Importantly, FDI inflows into developing countries over the last decade performed better when excluding China, an outsize presence in the FDI landscape historically. Not counting China, accumulated FDI during 2019–23 fell by just under 1 percent versus the prior five years compared with a 3 percent decline for all developing countries. As a share of GDP, developing countries excluding China also performed better than the entire cohort. 4 © MIGA, 2024 Executive summary FIGURE ES.1 FDI inflows into developing countries, 2010–23, $ billions and percent of GDP FDI into 800 3.5 developing 700 3.0 countries has been on a 600 2.5 downward slope 500 for more than a 2.0 decade 400 1.5 300 1.0 200 100 0.5 █ $ billions, LHS — Percent of GDP, RHS 0 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: World Development Indicators database (World Bank). Greenfield FDI, a component of cross-border investment, has fared much better. Greenfield investments are especially important for developing countries because they bring new and additional resources, capital, and assets to a country. Although overall FDI flows into developing countries fell in 2022 and 2023, the value of greenfield investment announcements reached nearly 80% $750 billion in the latter year, the highest annual level on record. FDI into computer-related sectors has thrived, as has investment in mineral resources projects in low-income countries. The year-on-year Reinvested earnings in developing countries, a component of FDI, have been rising both in value decline in FDI and as a share of FDI. For developing countries reporting such data, reinvested earnings set inflows into China new records in 2021 and 2022, surpassing three-fifths of FDI in the latter year. Exchange-rate in 2023 fluctuations, interest rate differentials, and the high cost of borrowing are influencing this trend, although reinvested earnings may also represent a vote of confidence in the local company and the host country. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK The United States has maintained its status as the foremost outward investor, but China is becoming an increasingly important source of cross-border capital. One important reason for this in recent years is China’s aim to preserve its access to large Western markets by relocating capital from domestic production to third counties considered friendlier to the United States and Europe. Chapter 2 An examination of the recent FDI and trade literature reveals that developments in the global economy are transforming the current FDI landscape. (See appendix 2 for more on this.) Reassessing their strategies, multinational enterprises are considering the transfer of production of goods and services to locations nearer to their home countries—referred to as near-shoring—or to their home countries themselves—referred to as reshoring—driven by geopolitical considerations, as well as cost factors, better market access, and supply chain resilience, among others. Additionally, multinational companies are shifting production to places that are politically aligned with the interests of their home countries—referred to as friend-shoring. The motivation is to create supply chains within (and outside) multinational enterprise networks that are robust and secure. 5 © MIGA, 2024 Executive summary FIGURE ES.2 Impact of friend-shoring on FDI relocations, percent of respondents Most IPAs expect 80 friend-shoring to 70 have positive 60 effects on FDI 50 40 30 █ All countries 20 █ Developing countries 10 0 Strongly positively affected Positively affected Negatively affected No change in investment (e.g., significant increase (e.g., modest increase (e.g., modest divestment/ due to friend-shoring Source: MIGA-WAIPA Survey. in FDI inflows) in FDI inflows) decrease in FDI inflows) Note: IPA = investment promotion agency. In a world where near-shoring and friend-shoring are increasingly important, geopolitical proximity and alliances matter. For example, US FDI flows into Mexico rose from $34 billion in the five years from 2014 to 2018 to $45 billion in 2019–23. As companies seek shorter supply chains and less geopolitical uncertainty, Mexico has become a favored manufacturing hub for the North American 86% market. Chinese companies have responded to friend-shoring in the United States and Western Europe by channeling FDI to rival manufacturing hubs with better access to the US and European markets. China’s FDI to Vietnam, Mexico, and Malaysia, for example, has soared. In 2023, The share companies in China invested 13 times more in computer manufacturing in other countries than of surveyed investment they invested in 2022 and five times more than the annual average in the previous decade. promotion To explore the relocation of FDI in recent years, and to assess the outlook regarding near-shoring, agencies in developing friend-shoring, and reshoring, the Multilateral Investment Guarantee Agency (MIGA) in 2024 counties who say commissioned a survey of investment promotion agencies (IPAs), with the support of the World friend-shoring will Association of Investment Promotion Agencies (WAIPA). be an important trend IPAs are optimistic about the benefits from friend-shoring, citing compatibility with FDI source SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK countries and supply chain integration with multinational enterprises. The findings reinforce the view that friend-shoring and near-shoring are expected to play a key role in the transformation of the FDI landscape in the coming years. Nearly 80 percent of all IPAs, and almost 90 percent of those in developing countries, said friend- shoring would be very important or moderately important during the next three years; similar numbers of IPAs have the same view of near-shoring. The majority of IPAs also believe that both friend-shoring and near-shoring will offer new opportunities to attract FDI. However, the extent to which positive impacts from near-shoring and friend-shoring on FDI flows will materialize across many or most countries is questionable; some countries will inevitably lose out. Chapter 3 Chapter 3 looks at new and emerging risks for FDI as well as at recent trends in the use of mitigation instruments offered by political risk insurers. For host countries, the ability to navigate the risks in the FDI landscape will be essential for attracting such investment. Inevitably, risk perceptions reflect new and ongoing developments. For example, the COVID-19 pandemic, followed by the commodity price shock, caused significant economic disruptions and negatively 6 © MIGA, 2024 Executive summary impacted many countries’ sovereign balance sheets, increasing sovereign risk. Economic challenges led to foreign exchange shortages in several countries, resulting in transfer and convertibility restrictions. They also complicated the ability and willingness of national governments, state-level authorities, and public enterprises to honor contractual obligations with foreign investors. Economic hardship has accentuated risks associated with political violence, while interstate and internal conflicts have increased. The MIGA-WAIPA Survey underscored that the risks of adverse, unclear, and nontransparent regulations in host countries, as well as war and civil disturbances, are the top concerns when considering investing in developing countries. FIGURE ES.3 Ratio of PRI issuance to FDI flows into developing countries, 2005–23, percent  The ratio of PRI 14 issuance to FDI 12 flows into 10 developing 8 countries has declined over 6 time 4 2 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: Berne Union Secretariat; World Development Indicators database (World Bank). At a time of heightened perceptions of new and traditional political risks, political risk insurance (PRI) for investment offers an effective mitigation instrument, including against those risks underpinning near- and friend-shoring, which are often not under the control of individual host governments. However, only a small portion of annual FDI flows is covered by PRI, exemplified by the low value of the ratio of PRI issuance to FDI inflows to developing countries—around 7 percent 7% in 2020–23. The post-pandemic rebound in PRI issuance for investment by members of the Berne Union (the association representing the global export credit and investment insurance industry) has SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK New PRI been slow and has not yet reached its pre-pandemic levels. Importantly, however, the ratio of PRI issuance as a issuance to FDI flows has been significantly higher for lower-income countries. ratio of FDI flows into developing Although PRI issuance and FDI inflows to developing countries do not go hand in hand, PRI countries, issuance in 2023 experienced a small decline, mirroring the decline in FDI flows to developing 2020–23 countries. Taking a longer-term perspective, PRI issuance has been on a declining trend despite elevated concerns over political risks by investors. Public sector PRI providers (mostly export credit agencies) continue to play a pivotal role in supporting multinational enterprises from their home countries, contributing to the bulk of PRI issuance among Berne Union members. Although multilateral PRI providers, such as MIGA, have managed to double their issuance share, their starting point was relatively modest. Multilateral providers are, however, more likely to be issuing guarantees in riskier environments aided by first- loss and blended-guarantee instruments, helping support FDI flows there. Reflecting elevated sovereign debt and foreign exchange risks, PRI claims for losses concerning transfer and convertibility risk, historically negligible, experienced an uptick following the pandemic, as did claims related to political violence. Yet there remains enough capacity in the PRI industry to handle these. 7 © MIGA, 2024 Executive summary Conclusion Foreign direct investment into emerging markets and developing economies has been on a broadly downward path for more than a decade. This is of concern for the many developing countries that rely on cross-border capital to support growth. The onset of friend-shoring and near-shoring— manifestations of geopolitical fragmentation—are further disrupting the FDI landscape and represent issues generally out of the control of most EMDEs. Focusing on traditional investment determinants, such as a business-friendly regulatory environment, the availability of skilled labor, and the quality of infrastructure, remains critical. Some slices of the FDI pie continue to be encouraging for EMDEs, such as announced greenfield investments. For countries that are well integrated into global supply chains, this is a positive development. In particular, greenfield FDI announcements into computer-related sectors have soared in recent years. Middle-income countries with strong infrastructure and geopolitical proximity to investors’ home countries will be the biggest potential beneficiaries of near-shoring and friend-shoring. Low-income countries, which typically have less well-developed infrastructure, are not as likely to benefit from FDI relocations. Even so, low-income and middle-income countries both have opportunities to benefit from FDI associated with the green energy transition, especially if they put in place investment-friendly and climate-focused policies. Low-income countries, in particular, have been recipients of rising levels of mining-related FDI, an outgrowth of the demand for metals considered critical to renewable energy production, such as copper, cobalt, and lithium, among others. In a new MIGA survey, as many as 80 percent of investment promotion agencies say friend- shoring and near-shoring will have positive effects on their countries. These views are almost certainly too optimistic. All or most countries cannot benefit simultaneously from FDI relocations driven by friend-shoring or near-shoring. That so many IPAs see a rosy outcome from FDI relocations suggests that a painful surprise may await some or many of them. The best course of action for IPAs is to refocus on the long-standing determinants of FDI: a conducive regulatory SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK environment, a supportive business climate, access to skilled labor, moderate taxation, and good infrastructure, among other factors. A very small—and declining—portion of FDI is covered by political risk insurance, yet political risks abound and have intensified in recent years. Near-shoring and friend-shoring trends are a reflection of this. Greater investor awareness of how these risks can be insured, as well as new products tailored to investor needs, including in the context of the green transition, can support FDI, especially in challenging environments. Multilateral providers may be particularly well positioned to address political risks because of their perceived neutrality and the ability to leverage their convening power to de-escalate disputes before they develop into claims. 8 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 9 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Key messages  Foreign direct investment (FDI) into emerging markets  Middle-income countries with strong infrastructure, and developing economies (EMDEs) has been on a trade links, and conducive regulatory environments will broadly downward path for more than a decade. This is be the biggest potential beneficiaries of near-shoring of concern for the many developing countries that rely and friend-shoring. Low-income countries, with less on cross-border capital to support growth. business-friendly environments, are not as likely to benefit from FDI relocations driven by near-shoring and  The downturn is the result of myriad causes, including friend-shoring. slower global economic growth, external shocks, and structural changes in investment and supply  Low-income and middle-income countries both have chains. Newer challenges, including global trade and opportunities to benefit from FDI associated with the investment protectionism, are adding to the pressures. green energy transition, especially if they put in place investment-friendly and climate-focused policies.  The onset of friend-shoring and near-shoring— manifestations of geopolitical fragmentation—are  Some slices of the FDI pie remain encouraging for generally out of the control of most EMDEs. Focusing EMDEs, such as announced greenfield investments. on traditional investment determinants, such as For countries that are well integrated into global supply availability of skilled labor and quality of infrastructure, chains, this is a positive development. remains critical, but they may not always be sufficient.  Low-income countries have been recipients of rising  China’s recent economic slowdown has weighed on levels of mining-related FDI, an outgrowth of the FDI in EMDEs overall. The FDI picture for EMDEs looks growing demand for metals considered critical to the better when China is excluded from the picture. green energy transition, such as copper, cobalt and lithium, among others.  Most developing country FDI goes to upper-middle- income economies and is highly concentrated. Almost  Greenfield FDI announcements into computer-related 70 percent of FDI goes to just six countries. sectors in EMDEs have soared in recent years. Greenfield FDI is also climbing in construction and  South Africa and India recorded the largest increases in power generation, potentially enhancing investment FDI over the last five years. Vietnam is now a top-five environments in EMDEs that could improve country for FDI inflows, and has become a middle- development outcomes. income country in one generation.  Reinvested earnings, a component of FDI, are  Low-income countries receive a tiny fraction of all increasingly important for EMDEs. When multinational TRENDS IN FOREIGN DIRECT INVESTMENT EMDE FDI, although the share has averaged as much companies reinvest profits, they are signaling as 4 percent of gross domestic product (GDP) in recent confidence in the country, even if some of the capital years, twice the ratio in most larger countries. movements reflect tax or corporate balance sheet considerations.  Around half of all FDI into EMDEs in recent years has flowed into East Asian countries, with about a quarter  China has become a major outbound FDI investor and going to Latin American and Caribbean economies. now ranks third globally, behind the United States and Other regions typically have single-digit shares. Japan. Much of China’s FDI goes to EMDEs. 10 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Overview Foreign direct investment (FDI) has powered prosperity in developing countries for nearly half a century. Yet FDI flows into these markets essentially have been stagnant for more than a decade despite year-to-year fluctuations, a result of subdued global economic growth, external shocks, and structural changes in investment and supply chains. More recently, geopolitical competition has added to the headwinds, including decisions by companies to invest in countries that are nearby geographically or more closely aligned politically with home markets. Thus, FDI flows are more likely to be influenced by a wider range of factors, many of them outside the control of host country policies, and developing countries are likely to attract less FDI if they are not aligned with major geopolitical players or if they are outside trade alliances. This comes at a time when developing countries need substantial gains in private sector investment to boost growth and job creation, combat climate change, and support the shift to more sustainable development. FIGURE 1.1 FDI inflows into developing countries, 2010-23 $ billions and percent of GDP FDI into 800 3.5 developing 700 3.0 countries has been on a 600 2.5 downward slope 500 for more than a 2.0 decade 400 1.5 300 1.0 200 100 0.5 █ $ billions, LHS — Percent of GDP, RHS 0 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: World Development Indicators database (World Bank). SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK FDI into developing countries1 has been on a broadly downward trend since the recovery from the global financial crisis of 2008–09, interrupted only by a post-COVID-19-pandemic investment surge in 2021 and record FDI flows into China that year (figure 1.1). To see past the volatility in annual FDI inflows, this report often looks at FDI over five-year periods, typically during the last decade, when geopolitical tensions and supply chain disruptions have been most pronounced. For the five years from 2019 to 2023, FDI inflows into developing countries totaled $2.8 trillion (in nominal terms),2 down 3 percent compared with the previous five years. Because developing country economies continued to grow during this period, FDI inflows as a share of nominal GDP fell from 2.1 percent (average for 2014–18) to around 1.7 percent (2019–23), the first sustained FDI-to-GDP ratio below 2 percent since the mid-1990s. Importantly, and as discussed later in this chapter, FDI inflows into developing countries performed better when excluding China, an outsize presence in the FDI landscape historically and whose economy has slowed in recent years. 1 This report uses the World Bank’s country-income classifications to define developing countries, which comprise both low-income countries and middle-income countries. High-income countries are considered developed economies. The following are the World Bank’s per capita country income thresholds (in US dollars per year), as of July 2023: low income, less than $1,135; lower middle income, $1,136–$4,465; upper middle income, $4,466–$13,845; high income, more than $13,845. 2 All FDI figures used in this report (inflows and outflows) are on a net basis, meaning that new inflows heading in either direction are reduced by outflows (divestment, repatriation of profits or repayment of loans) from the invested enterprise. 11 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries The onset of the COVID-19 pandemic in 2020 was responsible for some of the recent slowdown. FDI inflows to developing countries bounced back strongly in 2021, edging past the previous high in 2013. But the gains did not last: developing country FDI inflows fell again in 2022, by 19 percent, and by a further 30 percent in 2023.3 Investment was held back by a constellation of shocks. Consumer price inflation, post-pandemic, soared to an average of 9.6 percent globally in 2022 (World Bank 2024a), prompting sustained increases in policy interest rates by most countries. The higher cost of capital slowed investment, as did the energy shock spurred by Russia’s invasion of Ukraine, which led to a more than doubling of the average global oil price4 between 2020 and 2022 and a spike in world food prices, with negative implications for growth in many developing countries. The average oil price declined by around 17 percent in 2023, and food prices also retreated,5 leading to a substantial drop in inflation. Even so, GDP growth remained subdued in 2023, as did FDI flows. In fact, FDI in developing countries was already softening before the pandemic in terms of both the dollar value of flows and as a share of GDP. More broadly, private capital flows to developing countries, overall, have been decreasing. Following a boom during the first decade of this century, the second decade marked either a stagnation or decline in these private flows. After a brief recovery from the 2008–2009 global financial crisis, international private capital flows to developing countries have declined sharply (Ratha 2023). SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 3 This trend is consistent with other data collectors that report overall balance-of-payments figures from national governments, such as the IMF and OECD. 4 Brent blend North Sea crude oil, as traded on the Intercontinental Exchange (ICE). 5 A World Bank index of food commodities prices climbed by nearly 50 percent between 2020 and 2022 (annual average) before falling by almost 10 percent in 2023. 12 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Global FDI trends This chapter focuses on FDI in developing countries, but linkages in the world economy require an understanding of global trends as well. Like developing country FDI, global flows have also been trending lower, but the declines have been sharper. For the five years from 2019 to 2023, global FDI inflows totaled $7.9 trillion, down by around 26 percent from the previous five years (2014–18). As a percentage of annual nominal GDP, global FDI fell from 2.7 percent to around 1.6 percent (figure 1.2). FIGURE 1.2 Global FDI inflows as a percent of nominal GDP, 1998–2023 Global FDI has 6 been declining as a share of GDP 5 4 3 2 1 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: World Development Indicators database (World Bank). Historically, FDI is influenced by real GDP growth in the global economy, and while the outlook for growth is more encouraging than in the past, it remains subdued by historical standards. The World Bank’s June 2024 Global Economic Prospects noted that the “global economy is stabilizing, following several years of overlapping negative shocks” but also cautioned that “global risks remain SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK tilted to the downside despite the possibility of some upside surprises.” Global growth is projected at 2.6 percent in 2024, the same as in 2023. It is forecast to increase marginally to an average of 2.7 percent in 2025–26. Growth in emerging markets and developing economies is forecast to be around 4 percent in 2025–26, slightly lower than the estimated 4.2 percent in 2023. Growth in low-income countries is projected to accelerate to 5–5.5 percent in 2024–26 compared with 3.8 percent in 2023. This forecast is, at best, only mildly encouraging for global FDI. The stagnation in FDI flows to developing countries, in dollar terms, can be placed in the context of the sharp drop in global FDI flows in the last decade. The global decline is largely a reflection of declining flows in developed countries, which accounted for around 70 percent of all FDI flows during the last decade and which fell by a quarter between 2014–18 and 2019–23. It should be noted that flows between developed economies, or between developed and developing 2024-26 █ All countries █ Developing economies, do not always represent actual investment in productive assets. A significant portion of FDI between developed economies involves flows moving in and out of a conduit country on their way to a final destination, often using special purpose entities (SPEs). These are legal structures set up to obtain specific advantages from a host or transit economy, in which they have little to 13 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries no employment, physical presence, or production.6 Usually, SPEs are designed to benefit from advantageous tax regimes. As such, flows moving via SPEs do not necessarily shed light on investment in middle- and low-income economies (Goksu, Bikoi, and Gobin 2022). In the context of global FDI, inflows to developing countries have fallen less than inflows to developed economies (figure 1.3). Indeed, FDI flowing into developing countries, as a share of the total, has been edging upward since the start of the millennium. In the first dozen years of this century (2000–2011), developing countries accounted for around 21 percent of all FDI inflows; during the last dozen years (2012–23), they accounted for around a third of inflows (figure 1.4). The developing country share has, however, been slipping in more recent years. FIGURE 1.3 FDI inflows to developing and high-income countries, 2014–18 vs. 2019–23, $ billions High-income 12,000 countries bore the brunt of the 10,000 FDI slump 8,000 6,000 4,000 2,000 █ 2014–18 █ 2019–23 0 Global Developing High income Source: World Development Indicators database (World Bank). FIGURE 1.4 FDI into developing countries as a percent of all FDI, 2000–23 Developing 70 countries have SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 60 increased their share of all FDI 50 since the 2008–09 40 recession 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: World Development Indicators database (World Bank); International Monetary Fund. Note: FDI inflows into high-income countries fell sharply in 2018, mostly owing to significant activity by special purpose entities or one-off tax changes in those countries. The reduction in global flows increased the share of developing country FDI that year. 6 Countries with notable SPEs include Luxembourg and the Netherlands, which have drastically impacted FDI trends and induced volatility. For example, FDI inflows to the Netherlands fluctuated from $200 billion in 2017 to minus $300 billion in 2018. 14 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries BOX 1.1 Understanding FDI and its components FDI is defined as the net inflow of investment to ac- may take the form of greenfield investment, where quire a lasting management interest (10 percent or the investor starts a new venture in a foreign coun- more of the voting stock) in an enterprise operating try by constructing new operational facilities; joint in an economy other than that of the investor.a It is ventures, where the investor enters into a partner- the sum of equity capital, reinvestment of earnings, ship agreement with a company abroad to establish intercompany debt transactions, and other long- a new enterprise; or mergers and acquisitions, as and short-term intra-company loans as shown well as brownfield investments, which can take in the balance of payments. The flow data in this the form of simply buying an existing enterprise or report indicate net inflows: new investment inflows buying it and injecting additional capital into its op- less disinvestment in the reporting economy from erations. Non-equity forms of engagement between foreign investors. It is worth noting that many coun- foreign investors and local companies, typically tries fail to report reinvested earnings (since these contractual arrangements, may also be considered do not cross borders, they need to be estimated a mode of entry into host country markets. separately) and that the definition of “long-term Figures on FDI flows in this report come from loan” differs among countries. the World Bank’s World Development Indicators The key feature of FDI—acquiring lasting manage- database. They are based largely on balance of ment interest or effective control of an enterprise payments data reported to the International Mon- in another country—typically involves establishing etary Fund (IMF). These data are supplemented by manufacturing facilities, infrastructure projects and World Bank staff estimates using data from United mining operations, with services (health care, trans- Nations Trade and Development (UNCTAD) and portation, information technology, and so on) be- official national sources. coming increasingly dominant. Direct investments a. The internationally accepted definition of FDI (from the sixth edition of the IMF’s Balance of Payments Manual [2009]), includes the following components: (i) equity investment, including investment associated with equity that gives rise to control or influence; (ii) investment in indirectly influenced or controlled enterprises; (iii) investment in fellow enterprises; (iv) debt (except selected debt); and (v) reverse investment. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 15 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Why FDI matters and how it has shifted FDI is a key driver of growth and prosperity in many developing countries. As the World Bank and others have long noted, FDI helps link a country’s economy to global value chains and often allows developing countries and their businesses to improve their economic value add through the transfer of technology, development of skills, new management practices, and increased competition. The capital inflows from FDI can lead to new jobs and increased exports but also generate positive supply chain spillovers for domestic companies. The ability to attract FDI inevitably depends on a conducive policy, legal, and institutional environment and on the effective implementation of investment strategies. In a global landscape deeply impacted by conflict, climate change, contagious diseases, and growing political divisions, yet still subject to rapid technological change, countries are under pressure to refine their value propositions as investment locations and tackle barriers affecting all phases of the investment life cycle.7 At the global level, the World Trade Organization has finalized the Investment Facilitation for Development Agreement, the first global pact aimed at facilitating FDI flows (box 1.2). FDI flows into developing countries can differ substantially based on the size and type of economy, income level, industrial development, and business and investment policies. China, the world’s second-largest economy (nominal GDP of $17.8 trillion in 2023), has accounted for 30–40 percent of annual developing country FDI inflows since 2000. The large decline in China’s FDI inflows in 2023—to $42 billion from $190 billion the year before and from an annual average of $234 billion in the prior decade—will influence any analysis of FDI into developing countries. Indeed, FDI inflows into developing countries excluding China have performed better than FDI into all developing countries in recent years. For example, the FDI-to-GDP ratio for developing countries excluding China was 2 percent between 2019 and 2023, compared with 1.7 percent for all developing economies. In nominal dollar terms, developing countries minus China experienced a 1 percent decline in FDI between 2014–18 and 2019–23 versus a 3 percent drop for the entire cohort (figure 1.5). SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK FIGURE 1.5 FDI inflows into developing countries, excluding China, 2010–23, $ millions and percent of GDP FDI into 450,000 3.0 developing 400,000 countries ex China 2.5 has held up better 350,000 than developing 300,000 2.0 country flows 250,000 overall 1.5 200,000 150,000 1.0 100,000 0.5 50,000 █ $ millions — Percent of GDP 0 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: fDi Markets; UNCTAD 2024d. 7 See “Investment Climate,” World Bank: https://www.worldbank.org/en/topic/investment-climate#:~:text=Expanding%20Investment%20 Opportunities%3A%20Attracting%20FDI,and%20business%20practices%20to%20countries. 16 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries The recent FDI slump in China is mostly due to a slowdown in GDP growth, although companies increasingly are concerned about business conditions. A September 2024 report from the EU Chamber of Commerce in China noted perennial market access and regulatory barriers but also cited the government’s more recent focus on national security and on developing a high degree of self-reliance. The chamber said profitability for foreign firms had declined, adding, “A sentiment is emerging at company headquarters and among shareholders that the returns on China investments are no longer commensurate with the risks faced” (EU Chamber of Commerce 2024). Investment Facilitation for Development Agreement: An opportunity to catalyze BOX 1.2 investment climate reforms The World Trade Organization (WTO) Investment Facilitation dle-income countries that have the lowest levels of adoption for Development Agreement (IFDA) is the first international of investment facilitation measures.c The IFDA could generate investment agreement at the global level. During the 13th WTO global welfare gains between 0.63 percent and 1.73 percent Ministerial Conference in February 2024, and after six years ($295 billion and $1.04 trillion) (Balistreri and Olekseyuk 2021). of intense negotiations, the agreement’s text was officially The adoption of the measures outlined in the IFDA can con- finalized. Currently the IFDA boasts participation from over 128 tribute to a more conducive investment climate by improving WTO Members spanning all regions, representing three-quar- transparency, efficiency, and effectiveness of investment-related ters of the WTO membership.a procedures and institutions. Strengthening these dimensions The IFDA has the objective to increase the participation of WTO is important for enhancing investor confidence, reducing Members in global investment flows. This is to be achieved by establishment and operational costs, and attracting and improving the domestic business climate and making it easier retaining investments (Kusek 2020). In line with global trends, for investors in all sectors to conduct business. The IFDA the IFDA also includes provisions that encourage the uptake provides rules that create clear and consistent global standards of responsible business conduct principles and standards by for investment facilitation measures, enhance transparency investors and enterprises, and the adoption of anti-corruption between governments and businesses, simplify and speed up measures. The aim is to help countries attract not only more but administrative procedures, provide a global forum to promote also higher-quality investments that contribute to sustainable best practices, and promote international cooperation.b The development. IFDA explicitly excludes market access, investment protections, Developing and least-developed countries may benefit from SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK and investor-state dispute settlement. the IFDA’s “Special and Differential Treatment” to implement the The IFDA presents an important opportunity for countries to agreement. This also includes the possibility for these countries generate reform momentum and better facilitate investment in a to undertake a needs assessment to identify implementation changing global context. Improving investment facilitation frame- gaps and technical assistance needs. Technical assistance works and the overall investment climate will be key for countries and capacity-building programs will be essential for on–the- to be able to take advantage of new FDI opportunities in the ground implementation of investment facilitation provisions. The growing services sector (Nayyar, Hallward-Driemeier, and Davies World Bank is already supporting several countries with such 2021), the clean energy transition (Saurav and Viney 2020), and needs assessments and is well positioned to support reform near-shoring trends caused by geopolitical tensions and efforts implementation going forward. The expected benefits from the to increase resilience of supply chains (World Bank 2022). The IFDA strongly depend on the implementation of the negotiated IFDA promises to be particularly beneficial for low- and mid- reforms.d Source: Brief prepared by D. Gomez Altamirano, PSD specialist, ETIIC, under the guidance of I. Nimac, S. Solf, and A. Akhlaque, ETIIC. a. See Investment Facilitation for Development: https://www.wto.org/english/tratop_e/invfac_public_e/invfac_e.htm. b. WTO, WT/MIN (24)/17, Joint Ministerial Declaration on the Investment Facilitation for Development Agreement, Article 1, 2024. c. Low- and middle-income countries have been identified as the main beneficiaries, according to a recent study modeling the potential economic impact of an IFDA (Balistreri and Olekseyuk 2021). See also Berger, Dadkhah, and Olekseyuk (2021). d. The World Bank Group is currently assisting WTO Members in undertaking the needs assessment exercise. 17 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Most developing country FDI goes to upper-middle-income economies and is highly concentrated Upper-middle-income economies dominate FDI inflows, accounting for more than 75 percent of the developing country total (figure 1.6), about the same as their share of nominal US dollar GDP. They also account for the majority of FDI stocks. That countries with large stocks of FDI should continue to attract most new flows should not be surprising since, as the World Bank has noted, “past investment in host economies is likely to be a greater determining factor of new investment moving forward” (World Bank 2023). FIGURE 1.6 FDI inflows into developing countries by income group, 2014–18 vs. 2019–23, $ billions Upper 2,500 middle-income economies attract 2,000 the majority of developing 1,500 country FDI 1,000 500 █ 2014–18 █ 2019–23 0 Upper middle income Lower middle income Low income Source: World Development Indicators database (World Bank). Developing countries’ FDI inflows have been concentrated in a handful of large markets in recent years. Six countries—China, Brazil, India, Mexico, Indonesia, and Vietnam—accounted for just under 70 percent of all developing country inflows in the period 2018–23 (figure 1.7). This was little changed from the prior five years, when the top six FDI recipients accounted for around 71 percent of developing country inflows. Indeed, five of the top six countries were the same over the SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK two periods; the only difference was Russia, which was present on the earlier list but absent from the more recent one. This is no surprise. Russia’s FDI inflows in 2022 were a negative $40 billion, almost certainly because of divestments by Western companies after Russia’s invasion of Ukraine early that year and subsequent waves of sanctions against Russia. But Russia’s FDI inflows had been waning ever since its first foray into Ukraine in 2014, when it annexed Crimea. In the eight years before the annexation, Russia enjoyed a boom in FDI, with flows averaging nearly $53 billion a year. Since then and excluding the net negative inflows in 2022 owing to new rounds of sanctions, inflows dropped to an annual average of less than $23 billion, a decline of more than half. 18 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries FIGURE 1.7 FDI inflows into developing countries, 2019–23, leaders by percent share Nearly 70 percent of FDI inflows are concentrated in a 31% All other developing countries 37% China handful of countries 3% Vietnam 4% Indonesia 6% Mexico 10% Brazil 9% India Source: World Development Indicators database (World Bank). Vietnam replaced Russia on the list of top FDI recipients for the period 2018–23. As the IMF has noted, Vietnam has “benefit[ed] from some business diversion from China” and has been able to attract significant sums of FDI, in part, by granting tax incentives to multinational enterprises (IMF 2023b). The International Finance Corporation (IFC) noted that private sector investment “has helped propel Vietnam to the ranks of a middle-income economy in one generation,” led by “large amounts of foreign direct investment (FDI) in labor-intensive segments of manufacturing global value chains (GVCs)” (World Bank 2021). Among developing countries with relatively large economies,8 Vietnam enjoyed the largest FDI inflows of any country as a share of GDP in the period 2019–23, averaging 4.5 percent, and totaling nearly $84 billion. South Africa reported the largest increase in cumulative FDI inflows among developing countries (in US dollar terms) between 2014–18 and 2019–23, rising by around $44 billion (to $62 billion from $17 billion) (figure 1.8). This increase was heavily influenced by inflows in one year, 2021, when SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK South Africa attracted around $40 billion in FDI, about 10 times more than its annual average in the 2010s. South Africa’s Central Bank attributed much of the increase to technology investor Prosus, a Netherlands-based company, purchasing a significant share of its South African parent, Naspers. Beyond that, extractive industries remain important to South Africa’s economy; minerals made up around 23 percent of its 2022 exports and precious metals another 23 percent. Even so, FDI in South Africa is diverse. Many Western companies, including Vodaphone (United Kingdom), Coca-Cola (United States), Volkswagen and BMW (Germany), Toyota (Japan), and Heineken (Netherlands), have investments in the country. Indeed, PepsiCo (United States) and Heineken have each concluded multibillion-dollar acquisitions of South African firms in recent years. 8 Countries with annual nominal US dollar GDP of $400 billion or more. 19 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Big FDI increases in smaller economies In percentage terms, the largest increase in FDI between 2014–18 and 2019–23 in developing countries was in Guyana, at 529 percent (figure 1.8). Guyana, with a population of just 800,000 and GDP valued at $16.5 billion in 2023, has enjoyed an FDI surge driven by investment in petroleum assets, especially by US oil companies ExxonMobil and Hess (which is being acquired by Chevron) and China National Offshore Oil Corporation. Oil production in Guyana expanded by more than 40 percent in 2023 (to nearly 400,000 barrels a day) and will account for around 65 percent of its GDP in 2024. FDI in Guyana is not large in US dollar terms, at $6.8 billion for the 2019–23 period, but it equalled just under 20 percent of GDP during that time, a sizable share. Senegal, a lower-middle-income economy and another leader in percentage terms among smaller countries, is also receiving FDI in hydrocarbons, led by BP, the UK oil major, and Kosmos, a US deepwater exploration company, which are investing in the Greater Tortue Ahmeyim (GTA) natural gas project, the deepest offshore liquified natural gas (LNG) operation in Africa. Senegal’s FDI during 2019–23 amounted to $11 billion, equal to around 8 percent of GDP. The Central African Republic and The Gambia, both low-income economies, also recorded significant gains in FDI between 2014–18 and 2019–23 in percentage terms. As a fragile and conflict-affected country, the political environment in the Central African Republic has been volatile: the government, with support from Russian security contractors and Rwandan forces, controls key cities, including the capital, while rebel groups hold other parts of the country. Even so, the economy has been able to attract FDI into diamond and gold mining and timber production, reflecting some improvement in the domestic security situation. It is worth noting that despite the large percentage increase, the Central African Republic attracted only around $75 million in FDI between 2019 and 2023, equal to around 6 percent of GDP. The Gambia, a West African country of about 2 million people, has been updating investment legislation and regional investment agreements following a policy review by UNCTAD in 2017 (UNCTAD 2024a). Foreign investors SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK FIGURE 1.8 Selected developing countries with large FDI increases, 2014–18 vs. 2019–23, $ millions and percent South Africa and 50,000 India reported the 40,000 largest increases in FDI inflows over 30,000 the last decade... 20,000 $ millions 10,000 0 South Africa India Indonesia Vietnam Oman ...but smaller 600 economies with 500 extractive projects 400 also enjoyed 300 significant gains in percentage terms 200 percent 100 0 Guyana Eswatini Senegal Gambia, The Central African Republic Source: World Development Indicators database (World Bank). Note: Excludes countries with negative net inflows. 20 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries FIGURE 1.9 FDI inflows into low-income and vulnerable countries, 2013–23, percent of GDP Fragile and 6 conflict-affected states receive less 5 FDI than other vulnerable 4 countries 3 2 █ Low income █ Heavily indebted 1 █ IDA █ Fragile/conflict 0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: World Development Indicators database (World Bank). Note: A country can appear in more than one of these groups. IDA = International Development Association. have taken an interest in the country’s manufacturing, agriculture, tourism, and information and communication technology (ICT) sectors. Green-focused development and digitization reforms are also under way; Wave, an African mobile money platform, established a presence in the country in 2022 (Mitchell 2023). FDI’s ability to move countries up the development ladder by creating jobs, improving economic value add, and transferring technology is particularly important for countries with the steepest paths to climb—those with low incomes or fragile and conflict-affected states9 (box 1.3). On the one hand, low-income countries’ share of developing country FDI, at around 2.8 percent of the total, is well below that of lower-middle-income countries (20.3 percent) and upper-middle- income countries (77.4 percent) (figure 1.6). On the other hand, FDI has risen as a share of GDP in low-income economies, from around 3.5 percent between 2014 and 2018 to 3.7 percent between 2019 and 2023. By contrast, the FDI-to-GDP ratio fell over the last decade for two other vulnerable groups of economies: IDA countries10 and fragile and conflict-affected states (figure 1.9). Importantly, though, in dollar terms, FDI into IDA countries has risen of late (figure 1.10). SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK FIGURE 1.10 FDI inflows into low-income and vulnerable countries, 2013–23, $ millions FDI has recovered 50,000 in IDA and indebted 45,000 economies 40,000 post-pandemic but 35,000 not in low-income 30,000 and fragile states 25,000 20,000 █ IDA 15,000 █ Heavily indebted 10,000 █ Fragile/conflict 5,000 █ Low income 0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: World Development Indicators database (World Bank). Note: A country can appear in more than one of these groups. IDA = International Development Association. 9 “Fragile and conflict-affected situations” is a World Bank classification that covers the 39 countries considered to have (i) high levels of institutional and social fragility or (ii) those affected by violent conflict. See Classification of Fragile and Conflict-Affected Situations: https://www.worldbank.org/en/topic/fragilityconflictviolence/brief/harmonized-list-of-fragile-situations. 10 IDA countries are members of the World Bank’s International Development Association (IDA) and comprise the world’s poorer states. For purposes of this report, they include IDA-only countries and exclude IDA-blend countries. IDA countries are eligible to receive grants and low- interest loans from the World Bank. 21 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries BOX 1.3 FDI in challenging environments: Mozambique Fragile and conflict-affected states—those that are facing tur- ment in extractive projects, mostly natural gas, from companies moil or institutional and social fragility—have attracted less FDI like TotalEnergies, a French multinational that is supporting as a share of GDP in recent years, and much less than other liquified natural gas (LNG) production in the country. ExxonMo- vulnerable countries. bil, an energy company based in the United States, is expected to make an investment decision on its own LNG project in the When fragile economies have received significant amounts of next year. Despite delays and challenges in implementing the FDI, it has often been in extractive industries. Mozambique is onshore LNG projects, as well as wide year-to-year fluctuations, an example. Classified by the World Bank as an IDA country, a FDI in Mozambique has been trending upward. The develop- fragile and conflict-affected state, and a highly indebted poor ment of LNG facilities will also boost FDI in Mozambique in country (HIPC), its annual FDI inflows since 2010 have averaged related services industries, such as construction, infrastructure, nearly 23 percent of GDP, the highest in the world for any coun- financial, and legal, even as the country faces large fiscal and try (excluding offshore financial centers and other conduit econ- external deficits and is implementing reforms with the support omies). Mozambique’s FDI surge has been due mainly to invest- of an International Monetary Fund program. Greenfield investment has been rising of late Greenfield FDI is especially important for developing countries: it brings new and additional resources, capital, and assets to a country. Such new investment typically leads directly to increased output, employment, and improvements in productivity (IMF 2023a). Although overall FDI flows into developing countries fell in 2022, the value of greenfield investment announcements more than doubled, to $622 billion, one of the highest annual levels on record.11 This was, to a significant extent, a bounce back from the pandemic-induced business slump in 2020 and 2021, but the recovery proved durable. The value of greenfield announcements to developing countries climbed by another 20 percent in 2023 despite high global interest rates and political and economic uncertainties, as the effects of the commodity price shock eased, inflation decelerated, and growth showed signs of stabilization (figure 1.11). The performance of greenfield investment in recent years represented a positive development in an otherwise disappointing FDI environment. It is important to note, however, that the database used here records greenfield announcements, not realized FDI. In some cases, the announced project may never materialize. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK FIGURE 1.11 Value of announcements of greenfield FDI in developing countries, $ millions and percent of global greenfield Greenfield FDI 900,000 70% in developing 800,000 countries 60% rebounded 700,000 50% strongly from 600,000 the pandemic 500,000 40% 400,000 30% 300,000 █ Greenfield FDI, 20% developing countries, 200,000 $ millions, LHS 100,000 10% — Percent of global greenfield FDI, RHS 0 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: fDi Markets; UNCTAD 2024d. 11 Data on greenfield FDI are from fDi Markets, a data provider owned by the Financial Times, as reported by UNCTAD in the annex to its World Investment Report 2024. The figures reflect project announcements, not necessarily implementation. The greenfield FDI figures do not include other forms of FDI, such as mergers and acquisitions, and reinvested earnings. 22 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Sectoral trends show a steady rise in nonmanufacturing FDI in developing countries, led by IT, construction, and power investment Sectoral figures in greenfield FDI show that services industries, when combined with construction and power generation, have overtaken manufacturing as the chief sectoral component of FDI in the last two decades, with information technology joining finance as major service sectors in recent years. Data on the value of FDI by sector are not available from official sources globally or regionally, but private sector providers collect information on announcements of greenfield FDI projects by sector.12 As the World Bank has noted, the services sector (along with construction) has been growing faster than manufacturing in many developing countries and is therefore playing a larger role in generating income gains and new jobs.13 The growth of FDI in the services sector (box 1.4), therefore, is a likely outcome of structural transformation and the expansion of the services BOX 1.4 FDI in services and clean energy are rising in developing countries New FDI opportunities are emerging in services and in the clean 2016 and tripled as a share of global GDP between 2014 and energy transition. 2022 (Hasna 2023). Increasingly, evidence shows that a sig- nificant number of climate policies are needed if EMDEs want Historically, FDI in developing countries has been concentrated to attract higher FDI flows into renewable energy, especially in in manufacturing and infrastructure projects. However, during countries with solar power potential and low dependence on the COVID-19 pandemic, investments in those projects dried fossil fuels. In particular, countries need a broad set of climate up, and announcements of greenfield investments in services policies for the electricity sector and must be prepared to adapt have now surpassed those in manufacturing. Looking ahead, their energy policies to changing technologies. Policies that new opportunities to attract FDI are emerging in the growing provide a revenue stream for investors early in the investment services sectors of developing countries, such as banking, cycle are particularly important. Attracting FDI into the electric transportation and logistics, tourism, and health care (World vehicle sector, for example, typically requires national sectoral Bank 2023). Moreover, the use of digital technologies and SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK strategies, prior comparative advantage in the automobile the possibilities for remote delivery allow service providers to sector, and bilateral alliances with large global EV players. For access larger markets and spread benefits as upstream ena- green hydrogen, comprehensive national hydrogen strategies blers and downstream complements for manufactured goods that leverage international efforts to boost production, and (Nayyar, Hallward-Driemeier, and Davies 2021). good conditions for production of renewable energy, appear to Investment opportunities in the clean energy transition are also be key drivers of FDI flows (Jaumotte 2024). growing. While investment in sectors classified as “green” by Although most FDI, including green FDI, goes to middle-income the EU—such as electric vehicles, battery storage, and solar countries, cross-border capital also flows to lower-income panels—has been much lower than in other sectors for the past regions. A study by the Carnegie Endowment for International two decades, the gap has narrowed significantly when looking Peace found that nearly $150 billion in greenfield and brown- at cross-border mergers and acquisitions and has disappeared field FDI went into energy sectors in African countries between in greenfield FDI into developing countries since 2020 (World 2012 and 2021. Although the majority of this went to fossil fuel Bank 2023). projects, around $40 billion, went into renewable energy projects As the IMF has noted, global green FDI has accelerated since involving solar, wind, biomass and hydropower (Carnegie 2023). 12 This sectoral data on greenfield FDI, like the figures reported in the previous section, is from fDi Markets. For this discussion on sectoral trends, we define services using the fDi Markets categories. The fDi database, and hence the analysis in this section, uses the International Standard Industrial Classification of All Economic Activities (ISIC), specifically the two-digit codes, to identify sectors. 13 The services sector accounted for 55 percent of GDP and 45 percent of employment in developing economies (Nayyar, Hallward-Driemeier, and Davies 2021). Services typically account for around 70 percent of GDP in advanced economies. 23 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries FIGURE 1.12 Announced greenfield FDI by sector, developing countries, 2010–23, $ millions Manufacturing 800,000 FDI remains important in 700,000 developing countries 600,000 500,000 400,000 300,000 █ Mining 200,000 █ Manufacturing 100,000 █ Construction, power █ Services 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: fDi Markets. economy more generally in developing economies (World Bank 2023), as well as ongoing services FDI policy liberalization. Manufacturing remains an important source of FDI for developing countries, ranging from 40 to 50 percent of all greenfield FDI announcements during 2010–24, according to the fDi Markets database.14 FDI in traditional services industries such as finance, retail trade, and transportation also held mostly steady during that period, at around 20–30 percent of the total. But the value of announced investments in developing countries in other nonmanufacturing sectors, such as construction, electricity, and water projects, has climbed in recent years, accounting for around 30 percent of all FDI in 2020–24 compared with 23 percent of the total in the prior decade (figure 1.12). Increased infrastructure development needs in some countries, including for power and telecoms projects and public-private partnerships, likely account for some of this increase. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK FDI distinctions between low-income and middle-income countries This report focuses on FDI in developing countries, but the sectoral composition of that investment differs between low-income and middle-income countries. Low-income countries typically have less well-developed infrastructure, for example, and regulatory regimes and labor markets are less conducive to FDI. But some types of FDI, such as in extractive industries, have been rising in low-income countries. Indeed, the value of greenfield FDI announcements in mining has averaged nearly 30 percent of all greenfield FDI inflows in low-income countries in the last four years (2020–23) compared with less than 5 percent in the previous four years (figure 1.13). This increase coincided with a sharp rise in a World Bank index of metals prices in 2021, which was driven both by a post-pandemic rebound in GDP growth globally and by a surge in demand for metals important to the green energy transition, such as copper (World Bank 2024c).15 The Democratic 14 In this section, we use categorizations from the ISIC, which defines 21 broad industries and 87 subsectors. These include (i) extractive industries (e.g., agriculture and mining), (ii) manufacturing (e.g., motor vehicles and chemicals), (iii) services (e.g., financial services and retail trade), and (iv) the supply of electric power, water, and construction. For this discussion, we distinguish between manufacturing, which traditionally comprises most FDI, and all other economic activities. 15 The price of copper rose by nearly 51 percent in 2021 from the year before. 24 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries FIGURE 1.13 Announced greenfield FDI by sector, low-income countries, 2014–23, percent of total Greenfield mining 100 investments have 90 risen in 80 low-income 70 countries, surpassing 60 manufacturing 50 40 █ Services 30 █ Construction, utilities 20 █ Manufacturing 10 █ Mining 0 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: fDi Markets. FIGURE 1.14 Announced greenfield FDI by sector, middle-income countries, 2014–23, percent of total Greenfield 100 investment in 90 construction and 80 utilities, proxies 70 for infrastructure, has risen in 60 middle-income 50 countries 40 █ Services 30 █ Construction, utilities 20 █ Manufacturing 10 █ Mining 0 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: fDi Markets. Republic of Congo (DRC), for example, was the recipient of $8.7 billion in announced greenfield SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK FDI between 2020 and 2023. DRC is the world’s largest cobalt producer and has significant lithium deposits, both of which are important components in rechargeable batteries. The composition of sectoral FDI in middle-income countries is concentrated more on manufacturing and on construction and utilities (figure 1.14). This is consistent with one of the themes of this report: the rise of near-shoring and friend-shoring, which require strong manufacturing hubs with generally good infrastructure. One of the lessons of this sectoral analysis is that low-income countries that are not candidates for near-shoring and friend-shoring but have the appropriate resource base can secure development gains by focusing on an investment regime that is conducive to FDI in extractive industries targeted on the green energy transition. 25 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Motor vehicle and computer FDI have been important to developing countries Greenfield FDI in motor vehicle production is the largest component within manufacturing in developing countries, accounting for around $500 billion between 2010 and 2023. Motor vehicle FDI started to edge downward in the latter half of the 2010s before falling sharply during the pandemic (figure 1.15). Although it has recovered, the developing country share of global greenfield FDI flows in motor vehicle manufacturing in 2023 is slightly lower than it was a decade ago. Four manufacturing industries—motor vehicles, chemicals, computers, and electrical equipment—have accounted for more than half of announced manufacturing FDI projects for developing countries since 2010. FIGURE 1.15 Motor vehicle FDI, greenfield announcements, developing countries, 2010–23, $ millions and percent Motor vehicle FDI 60,000 70 is important for 50,000 60 developing countries 50 40,000 40 30,000 █ Developing country 30 value, motor vehicles, $m, 20,000 20 LHS — Developing country, 10,000 10 percent, all motor vehicle FDI, RHS 0 0 Source: fDi Markets. 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 A surge in FDI for ICT services has been a major story for developing countries in recent years (figure 1.16). The pandemic accelerated the ongoing global move to digitalization, and developing countries have benefited from this development through an increase in announced FDI projects SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK in ICT. The value of ICT greenfield FDI projects in 2023 was more than $30 billion, 10 times the amount in 2015. Although high-income countries also recorded strong increases in ICT FDI, developing countries’ share of the total in that sector amounted to 40 percent in 2019–23 compared with​25 percent in 2014–18. FIGURE 1.16 Greenfield FDI announcements in computing infrastructure, data processing and hosting, developing countries, 2010–23, $ millions Computing 35,000 services have 30,000 been a major growth area for 25,000 developing countries 20,000 15,000 10,000 5,000 0 Source: fDi Markets. 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 26 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Reinvestment of earnings has been increasing in developing countries Countries are keen to attract new foreign investors, and as the previous section highlights, much attention has been focused on greenfield FDI. But FDI can also come from the reinvestment of earnings from existing foreign affiliates. Government policies that induce companies to reinvest earnings in host countries are as important as those that convince new investors to start operations. Indeed, reinvesting earnings in an established operation is often a vote of confidence in the company’s activities in the host country, and in the host country itself. Importantly, shifts in reinvested earnings can also reflect tax and balance sheet decisions by multinational companies, so increases are not always a sign of confidence in a host economy. Reinvestment of earnings also may have a disadvantage compared with greenfield investment in that it does not involve new market entrants, possibly reducing the benefits of new competition. Reinvested earnings have been rising in developing countries, both in nominal US dollar terms and as a share of overall FDI inflows (figure 1.17). The gains have been particularly strong in recent years: reinvested earnings for those countries that report them rose to more than $400 billion annually in developing countries in both 2021 and 2022—a record—and accounted for around 60 percent of total FDI flows reported by these countries in both years.16 FIGURE 1.17 Reinvested earnings in developing countries, 2011–22, $ millions and percent of total FDI Reinvested 450,000 70 earnings have 400,000 surpassed 60% 60 of FDI in 350,000 developing 50 300,000 countries 250,000 40 200,000 30 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 150,000 20 100,000 █ $ millions, LHS 50,000 10 — Percentage of all FDI, RHS 0 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Source: Balance of Payments database (International Monetary Fund). Note: Not including China. 16 China is by far the largest economy not to report reinvested earnings to the IMF. Other notable economies in this group include Saudi Arabia and South Africa. 27 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Spotlight: Historical and geographic shifts in FDI stocks FDI stocks reflect the accumulation of flows over time; stocks also measure the total level of direct investment at a given time (usually at the end of a quarter or a year). The outward FDI stock is the value of the resident investors’ equity in and net loans to enterprises in foreign economies. The inward FDI stock is the value of foreign investors’ equity in and net loans to enterprises resident in the reporting economy. FDI stocks are measured in US dollars and as a share of GDP.17 The United States remains the biggest single outward investor country, with an increase in its share of worldwide outward FDI stock from 12 percent in 2009 to 15 percent in 2022.18 While the stock of US outward FDI has been increasing consistently based on significant annual FDI outflows, the country’s share of worldwide stock has risen only modestly, reflecting the increase in the universe of outward investors. The European Union (EU28)19 remains the largest outward investor bloc, but its share of worldwide outward FDI stock has declined by more than 10 percentage points, from 54.2 percent in 2009 to 42.4 percent in 2022. The stock of FDI remains concentrated in developed countries. Developing countries accounted for only about 25 percent of the worldwide inward stock in 2022, little changed over the last decade. Developed countries continue to invest mostly in each other. The United States is the biggest investor in the EU28 and conversely the EU28 is the biggest investor in the United States. The corresponding shares for 2022 are 19.9 percent (share of US FDI stock into the EU28, as reported by the EU28) and 57.7 percent (share of EU28 FDI stock into the United States, as reported by the United States). China’s shares into the EU28 and the United States are relatively low: 9.1 percent and 2.4 percent, respectively, in 2022 (as reported by the EU28 and the United States), which represents an increase for the EU28 but a decline for the United States since 2009. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK China has become a significant outward investor during the past decade: it is now the largest developing country outward FDI investor in terms of the value of its outward FDI stock, which reached $2.93 trillion in 2022. China’s share of worldwide outward FDI stock increased from 5.1 percent in 2009 to 8.8 percent in 2022. The pattern of dominant outward investor countries/blocs in different regions is changing. In the past, the United States, Japan, and the European Union dominated inward FDI stocks into Latin America, Asia, and Eastern Europe, respectively (UNCTAD 1991), as reported by host countries in these regions. 17 As defined in OECD Data, s.v. “FDI stocks,” Benchmark Definition, 4th edition (BMD4): Foreign Direct Investment, https://data.oecd.org/fdi/fdi-stocks.htm#indicator-chart. 18 All FDI stocks figures in this section are sourced from the IMF’s Coordinated Direct Investment Survey (CDIS). 19 Including the United Kingdom for all years. 28 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries The EU28 maintains a strong presence in Eastern Europe, but also in Asia, Latin America, and Sub-Saharan Africa (figure 1.18). In 2009, EU28 FDI20 stock comprised more than 10 percent of the total inward FDI stock in 54 countries (excluding intra-EU28 FDI), a number that rose to 68 in 2022. The picture is quite diverse, with host countries concentrated in non-EU28 members, as well as Asia and Sub-Saharan Africa, where host countries maintain historical links with EU28 members. FIGURE 1.18 Countries in which European Union has more than 10 percent of FDI stock, 2009 and 2022 ECA* EAP 2009 2022 2009 2022 Serbia, Rep. of 88.2% Ukraine 79.3% Korea, Rep. of 41.4% Mongolia 49.2% North Macedonia, Moldova, Rep. of 74.9% Japan 36.3% Brunei Darussalam 40.5% 80.7% Republic of North Macedonia, Philippines 28.2% Korea, Rep. of 31.9% 74.0% ECA= Türkiye, Rep. of 76.4% Republic of Australia 27.6% Philippines 29.0% Europe and Central Asia Ukraine 73.6% Bosnia and 65.7% Indonesia 23.4% Japan 24.1% EAP= Russian Federation 63.7% Herzegovina Malaysia 22.8% Australia 23.4% East Asia & Pacific Albania 53.8% Bosnia and Herzegovina 61.4% Singapore 22.4% Singapore 18.2% LAC= Moldova, Rep. of 60.1% Kazakhstan, Rep. of 51.7% Latin America & Carbbean Thailand 18.9% Malaysia 14.9% Kazakhstan, Rep. of 51.9% Georgia 46.3% Mongolia 14.7% Thailand 14.1% MENA= Türkiye, Rep. of 45.8% Middle East and North Georgia 39.5% New Zealand 11.6% Indonesia 13.4% Azerbaijan, Rep. of 30.6% Belarus, Rep. of 42.5% Africa China, P.R.: Hong Kong 11.6% Armenia, Rep. of 23.9% Kosovo, Rep. of 40.8% NAM= North America Belarus, Rep. of 23.6% Montenegro 40.6% SAR= Kyrgyz Rep. 18.9% Azerbaijan, Rep. of 34.8% South Asia Members of the European Armenia, Rep. of 33.4% LAC SSA= Free Trade Association Kyrgyz Rep. 15.5% 2009 2022 Sub-Saharan Africa Iceland 92.3% Members of the European Free Trade Association Bolivia 65.6% Brazil 54.0% Switzerland 82.5% Norway 77.8% Paraguay 40.3% Bolivia 49.8% *ECA excludes EU28 Norway 60.5% Switzerland 65.0% Mexico 39.0% Mexico 48.9% countries Iceland 61.4% Honduras 32.6% Argentina 43.0% EU28 includes the UK Uruguay 21.5% Chile 34.0% Panama 20.9% Paraguay 33.0% Peru 18.9% Uruguay 26.0% NAM Costa Rica 18.8% Guatemala 25.2% 2009 2022 Barbados 14.0% Aruba, Kingdom of the 16.9% Netherlands SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK United States 64.5% United States 57.7% El Salvador 11.9% Costa Rica 16.2% Canada 27.4% Canada 33.8% Panama 13.5% El Salvador 11.8% Honduras 10.3% SSA 2009 2022 South Africa 70.4% South Africa 78.5% MENA Nigeria 65.1% Cabo Verde 74.8% 2009 2022 Botswana 47.0% Uganda 63.7% Morocco 88.6% Morocco 51.4% Seychelles 31.0% Botswana 58.4% Saudi Arabia 21.2% Lebanon 50.4% Uganda 30.8% Nigeria 47.7% Jordan 14.4% Algeria 43.0% Ghana 25.4% Ghana 36.9% Israel 12.8% Israel 12.2% Zambia 23.4% Mozambique, Rep. of 36.1% Mozambique, Rep. of 16.3% Benin 30.9% Tanzania, United Guinea 29.0% Rep. of 16.1% Togo 27.1% SAR Niger 26.9% 2009 2022 Seychelles 26.9% Bangladesh 38.9% India 34.4% Mauritius 14.3% Pakistan 30.8% Pakistan 30.4% Zambia 11.6% Nepal 10.2% Bangladesh 21.3% Rwanda 11.6% Sri Lanka 17.0% Burkina Faso 10.6% Nepal 13.1% 20 The United Kingdom is included in all years. The United Kingdom left the European Union in January 2020. 29 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries The United States continues to maintain a strong presence in Latin America and the Caribbean among developing countries (figure 1.19). In 2009, US FDI stock comprised more than 10 percent of the total inward FDI stock in 33 countries, a number that remained essentially unchanged at 32 in 2022. That same year, half (11 out of 22) of the developing economies in which the United States accounted for more than 10 percent of their reported inward FDI stock were in Latin America and the Caribbean. This compares with 10 out of 18 developing economies in 2009. FIGURE 1.19 Countries in which United States has more than 10 percent of FDI stock, 2009 and 2022 EAP ECA 2009 2022 2009 2022 Japan 37.5% Japan 27.8% United Kingdom 24.2% Ireland 38.4% Korea, Rep. of 20.6% Singapore 22.0% Netherlands, The 17.9% United Kingdom 35.8% EAP= Australia 20.0% Australia 16.5% Kazakhstan, Rep. of 16.4% Kazakhstan, Rep. of 28.4% East Asia & Pacific Philippines 17.2% Korea, Rep. of 15.2% Norway 15.2% Luxembourg 27.1% ECA= China, P.R.: Macao 15.0% Solomon Islands 14.2% Europe and Central Asia Switzerland 13.8% Netherlands, The 24.8% New Zealand 12.9% Philippines 11.9% Luxembourg 13.8% Switzerland 18.9% LAC= Latin America & Carbbean Malaysia 11.5% Malaysia 11.5% Georgia 12.9% Singapore 11.4% Indonesia 10.7% France 10.8% MENA= Middle East and North Mongolia 11.2% Spain 10.7% Africa Germany 10.5% NAM= North America LAC SAR= South Asia 2009 2022 NAM SSA= Costa Rica 63.7% Costa Rica 60.0% 2009 2022 Sub-Saharan Africa Mexico 49.9% Aruba, Kingdom of the 53.8% Canada 52.1% Canada 52.1% Aruba, Kingdom of the Netherlands 47.5% Netherlands Mexico 35.6% El Salvador 31.7% Honduras 23.7% Peru 26.4% Brazil 20.7% SAR Honduras 22.1% Argentina 20.0% 2009 2022 Panama 17.1% Guatemala 18.9% Bangladesh 13.1% Bangladesh 20.0% Paraguay 16.2% Panama 18.6% India 17.2% Bolivia 12.2% Trinidad and Tobago 17.8% Barbados 10.4% El Salvador 16.7% SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Paraguay 12.4% SSA 2009 2022 MENA Ghana 11.9% Mauritius 21.5% 2009 2022 Guinea 10.2% Israel 28.7% Algeria 29.2% Israel 22.3% FDI from China has a strong presence in Asia, but China’s reach is also expanding in Sub-Saharan Africa (figure 1.20). In 2009, China’s FDI stock comprised more than 10 percent of the total inward FDI stock in just three countries; by 2022, it had risen to 16. These countries were concentrated in Asia (South Asia, East Asia, and Central Asia) in both years, but in 2022 China’s presence in Africa became more apparent, with four countries entering the list of those in which China accounted for at least 10 percent of the inward FDI stock. 30 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries The United States and EU28 are becoming increasingly important sources of FDI for India, suggesting that an emergence of friend-shoring may be appearing in FDI stock figures. The United States accounted for 17.2 percent of the country’s inward FDI stock in 2022, compared with 16.5 percent in 2015, a marginal increase but one that supports the continuing move toward closer economic ties between the countries. The corresponding shares for China indicate a marginal decline, from 2.9 percent in 2015 to 2.4 percent in 2022. For the EU28, the corresponding share for India increased from 31.2 percent in 2015 to 34.4 percent in 2022, while the share in Mexico increased from 44.6 percent in 2015 to 48.9 percent in 2022. However, China’s share in Mexico has also risen, from 15.9 percent in 2015 to 19.4 percent in 2022. FIGURE 1.20 Countries in which China has more than 10 percent of FDI stock, 2009 and 2022 EAP ECA 2009 2022 2009 2022 China, P.R.: Hong Kong 37.4% China, P.R.: Hong Kong 31.6% None Tajikistan, Rep. of 60.7% Cambodia 23.9% Cambodia 30.5% Kyrgyz Rep. 16.7% China, P.R.: Macao 12.2% China, P.R.: Macao 23.2% EAP= Mongolia 18.6% East Asia & Pacific ECA= SSA Europe and Central Asia 2009 2022 SAR= SAR South Asia None Niger 57.1% 2009 2022 Benin 18.4% SSA= Sub-Saharan Africa None Sri Lanka 16.0% Guinea 11.7% Pakistan 13.3% Zambia 11.0% Nepal 10.8% SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK BOX 1.5 China’s growing presence as an outward FDI investor China has long been one of the world’s largest recipients of FDI, the single largest recipient of China’s outward greenfield FDI in even if inflows fell substantially in 2023. During the most recent 2023, accounting for 10 percent of the total, according to fDi 10 years (2014–2023), China attracted more than $2 trillion in Markets. Other countries that received a large share of outward inward FDI flows, the second-largest amount of any country, FDI include Malaysia (8.4 percent) and Vietnam (7.5 percent). behind only the United States ($3.5 trillion). But as the discus- As is discussed in chapter 2, the recent surge in China’s invest- sion of FDI stocks in this section shows, China’s role as an ment in these countries appears to be part of a move to shift outward provider of FDI flows has also become significant. For some capital away from domestic Chinese production sources, the five years from 2019 to 2023, China was the third-largest which may face import restrictions in Western countries, and outbound provider of FDI ($865 billion), behind only the United toward locations considered friendlier to the United States and States ($1.6 trillion) and Japan ($975 billion). As recently as Europe. In Africa, Morocco and Egypt attracted 6 percent and 2005–2010, China was the 10th-largest outward FDI investor, 5.1 percent of China’s outward greenfield FDI, respectively, behind not just the United States and Japan but Germany, while Argentina (4.8 percent) and Mexico (3.7 percent) were France, Italy, Canada and others.21 the largest recipients in Latin America (Wildsmith 2024). Each of these countries is relatively close either to the United States A significant share of China’s outbound FDI goes to developing or Europe and may be regarded as a potential near-shoring or economies, although Saudi Arabia, a high-income country, was friend-shoring locale. 21 The FDI rankings listed here exclude conduit economies. 31 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Conclusion FDI inflows into developing countries have been on a broadly downward trend since the global financial crisis of 2008–09, the result of myriad causes, including slower global economic growth, external shocks, and structural changes in investment and supply chains. Newer challenges, including global trade and investment protectionism, are adding to the pressures, and the COVID-19 pandemic took a heavy toll on FDI in 2020. To see past the volatility in annual FDI inflows, this report often looks at FDI over five-year periods, typically during the last decade, when geopolitical tensions and supply chain disruptions have been most pronounced. For the five years from 2019 to 2023, FDI inflows into developing countries totaled $2.8 trillion (in nominal terms), down 3 percent compared with the previous five years. Because developing country economies continued to grow during this period, FDI inflows as a share of nominal GDP fell from 2.1 percent (average for 2014–18) to around 1.7 percent (2019–23), the first extended FDI-to-GDP ratio below 2 percent since the mid-1990s. Importantly, FDI inflows into developing countries performed better when excluding China, an outsize presence in the FDI landscape historically and whose economy has slowed in recent years. FDI flows into developing countries remain concentrated in a handful of economies, with six countries—China, Brazil, India, Mexico, Indonesia, and Vietnam—accounting for nearly 70 percent of all developing country inflows during 2019–23. Numerous developing countries, mostly low-income economies, receive only small amounts of FDI, yet these amounts can represent a substantial share of their GDP. While some larger developing economies saw significant increases in FDI flows in terms of value between 2014–18 and 2019–23, a few smaller developing countries, mostly oil/gas and mining and mineral commodity exporters, recorded sharp increases in FDI flows in percentage terms between the same periods. Greenfield FDI is especially important for developing countries: it brings new and additional resources, capital, and assets to a country. Such new investment typically leads directly to SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK increased output, employment, and improvements in productivity. Although overall FDI flows into developing countries fell in 2022, the value of greenfield investment announcements more than doubled, to $622 billion, and rose again in 2023. Announcements, of course, are not the same as realized flows, and other significant differences exist in how different kinds of FDI are counted. Low-income and middle-income countries tend to attract different types of FDI. Low-income countries, with less developed infrastructure, are not a natural choice for manufacturing investment and are unlikely to become prime destinations for FDI relocations driven by near-shoring or friend-shoring. Low-income countries have, however, recorded a substantial increase in mining FDI in recent years, partly owing to the demand for metals that are critical to batteries and other components of the green energy transition. The movement to greener forms of energy represents an important opportunity for low-income countries that can create a conducive policy environment. A surge in FDI for ICT services has been a major story for developing countries in recent years. The pandemic accelerated the ongoing global move to digitalization and developing countries have benefited from this shift through an increase in announced FDI projects in ICT. 32 © MIGA, 2024 Chapter 1 Trends in foreign direct investment in developing countries Reinvested earnings, which allow foreign subsidiaries to expand operations in host countries without requiring additional financing from the parent firm or engaging in borrowing, are an increasingly important source of FDI for developing countries. Moreover, for the sizable group of developing countries that report such data, reinvested earnings accounted for over 60 percent of their FDI inflows. A high share of reinvested earnings in a host country may signal confidence in its business environment and favorable performance but may also reflect exchange rate, corporate tax or strategic considerations. The United States, the European Union, and China are the biggest outward investors worldwide in terms of FDI stocks. The United States remains the biggest single outward investor country, with a small increase in its share of worldwide outward FDI stock between 2009 and 2022. The European Union remains the largest outward investor bloc, but its share of worldwide outward FDI stock declined by more than 10 percentage points between the same years. China became a significant outward investor during the past decade, with its share of worldwide outward FDI stock close to doubling between 2009 and 2022, but from a small initial base. In sum, the global FDI landscape has experienced significant volatility, with the pandemic catalyzing a sharp decline in 2020 followed by a robust recovery in 2021. However, this rebound obscures a preexisting downward trend in FDI flows, particularly in high-income countries. Although not immune, developing economies have demonstrated some resilience. The FDI landscape will continue to evolve in light of recent developments that give rise to new investment opportunities for developing countries, discussed in chapter 2. 33 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring, and FDI relocations SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 34 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Key messages  Evidence is emerging that foreign direct  In a new Multilateral Investment Guarantee investment (FDI) is responding to economic Agency (MIGA) survey, investment promotion and geopolitical fragmentation. Increasingly, agencies (IPAs) rated Russia’s invasion of multinational enterprises are considering Ukraine and supply chain disruptions as the bringing production closer to home and/or two most important geopolitical risks they to economies more closely aligned with the expect to face during the next three years. political views of their headquarters country. Both are likely to have direct implications for friend- and near-shoring investment  Chinese companies have responded to the decisions. friend-shoring phenomenon in the United States and Western Europe by channeling  IPAs are acutely aware of the growing FDI to third countries, typically rival presence of near-shoring and friend-shoring manufacturing hubs with better access to in their interactions with foreign investors. the US and European markets. China’s FDI More than 80 percent of all IPAs said near- to Hungary, Malaysia, Mexico, and Vietnam, shoring would be an important trend during among others, has soared in the last two the next three years. Almost as many years, especially in the computer, electronics, expressed the same view about friend- and motor vehicle sectors. shoring.  The surge in China’s outbound FDI to these  As many as 80 percent of IPAs believe friend- competing hubs appears to be focused shoring and near-shoring will have positive on sectors that are politically sensitive in effects on their countries. These views are the ultimate destination country. In 2023, almost certainly too optimistic. All or most companies in China invested 13 times more countries cannot benefit simultaneously from in computer manufacturing in other countries FDI relocations driven by friend-shoring or than they invested in 2022 and five times near-shoring. That so many IPAs see a rosy outcome from FDI relocations suggests that SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK more than the annual average in the previous decade. The value of China’s FDI projects in a painful surprise may await at least some of motor vehicles and electrical equipment also them. soared.  IPAs should carefully and realistically assess  US FDI flows into Mexico rose from $34 the outlook for FDI relocations and prepare billion in 2014–2018 to $45 billion in themselves for unexpected outcomes. 2019–23. Data on mergers and acquisitions The best course of action is likely to be tell a similar story. Companies are seeking refocusing on the long-standing determinants shorter supply chains and less geopolitical of FDI: a conducive regulatory environment, uncertainty, elevating Mexico as a favored a supportive business climate, access to manufacturing hub for the North American skilled labor, moderate taxation, and good market. infrastructure, among other factors. 35 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Introduction Foreign direct investment is changing in ways that would have been inconceivable a few years ago. A half century of global economic integration, driven by trade, FDI, and the search for low labor and input costs, is shifting to a fragmented investment model increasingly defined by near- shoring, friend-shoring, and reshoring—each a way to gain greater control of supply chains and access to markets. (See appendix 2 for definitions of these phenomena and a more detailed discussion of underlying forces.) While it is apparent that a shift is occurring in certain countries, the full scope of this transition remains uncertain. The extent of investment reallocation, the areas and sectors of most significant impact, the duration of these changes, and the permanence of these trends are yet to be fully understood. At the heart of this shift is the growing importance of political risk as a constraint to FDI flows. This gives rise to the most pressing question: In a world where geopolitical competition seems to be progressively overshadowing globalization, what does the future hold for FDI? As a starting point, we acknowledge that the relationship between FDI relocation that is driven by near-shoring and friend-shoring (and reshoring) and general locational FDI decisions (that is, those related to traditional factors such as an attractive regulatory environment and access to skilled labor) is not always easy to separate and may not be possible to disentangle in the data. That said, the substantial and very targeted shifts in FDI and trade flows that appear in the data seem to suggest that something more than traditional investment determinants are at play. What can we learn from the data? Friend-shoring, near-shoring, and reshoring have been discussed extensively in the last few years by policy makers, business leaders, and economists. But reshoring, friend-shoring, and near- shoring are recent phenomena; evidence for them, while growing, is far from conclusive, nor is it clear that recent developments will persist. The onset of the pandemic in 2020 complicates the SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK analysis: GDP and most cross-border investment and trade flows fell substantially during the worst of the COVID-19 shock, then rebounded strongly, obscuring other trends. In some countries, FDI and trade flows have yet to recover to pre-pandemic levels. But geopolitical and economic fragmentation increasingly are part of the wider global economic story. A corollary to the deglobalization trend discussed earlier is the emergence of a multipolar world (Chase-Dunn, Álvarez, and Liao 2023). This chapter (and appendix 2) examines what recent data tell us about the movement of FDI and trade between major geopolitical players, mainly the United States and China, as well as the many other countries seeking opportunities. The picture is indeed one of FDI relocation, but it is also one of expediency as countries take advantage of opportunities. Countries and companies are also adjusting and compensating for the fragmentation by using third countries to circumvent some of the political restrictions at the core of fragmentation. We look at that phenomenon first. 36 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Trade, FDI relocations, and intermediate countries In 2003, around 12 percent of US goods imports came from China, and an almost equal share from Asian economies that are key contributors to global value chains: the Republic of Korea; Taiwan, China; Indonesia; Malaysia; the Philippines; Singapore; Thailand; and Vietnam. Over the next decade, China’s share of the US import market steadily climbed to more than 20 percent, while the other Asian economies’ share dropped to less than 10 percent before edging slightly higher. The pattern dramatically reversed in 2019. By the first half of 2024, China’s share of US imports had declined to around 13 percent, while the Asian countries’ share had risen to above 17 percent (figure 2.1). This shift in US imports away from China and toward countries in Asia considered friendlier to the United States started shortly after the United States raised tariffs on some of China’s exports in 2018, with China reciprocating. FIGURE 2.1 US merchandise imports from China and Asian countries, percent of all imports The US is shifting 25 toward friend-shoring in trade % of US goods imports 20 from selected Asian economies, $ terms 15 10 █ China Korea Rep.; Taiwan, China; 5 █ Southeast Asia 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Source: US Bureau of Economic Analysis. Note: Southeast countries include Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam. Includes first quarter of 2024. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK In response, both Chinese companies and foreign investors based in China have been relocating FDI into third countries—typically rival manufacturing hubs—to access the US market via these destinations. Such relocations (also reflected in the trade data shown in figure 2.1) allow Chinese or foreign-owned manufacturers in China to invest in an intermediate country that serves as a conduit to access increasingly difficult-to-reach US and EU markets, as well as other developed economies. Data from fDi Markets, a provider of greenfield FDI figures, dramatically illustrates this point, with Vietnam and Mexico emerging as the most popular conduits. In 2023, companies in China announced 39 new greenfield FDI projects in Vietnam and 42 in Mexico, both records. Vietnam, for example, received $6.2 billion in investments in 2023 from China for 13 electrical equipment projects, and another $3.9 billion the same year in Chinese FDI for computer manufacturing. The story was much the same for Mexico, even if the sectors were different. Companies in China invested $4.1 billion in the motor vehicle industry in Mexico in 2023, spread across 17 projects, as well as nearly $700 million in metals manufacturing. 37 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations FDI relocation from China was not confined to Vietnam and Mexico. Large increases in outward FDI from China was evident elsewhere in Asia, including in Indonesia, Malaysia, and Thailand, and even in the Republic of Korea, a high-income country (figure 2.2). Consistent with the near- shoring and friend-shoring trends, the number of new projects from China also rose substantially in lower-cost manufacturing locations with easy access to Europe, including Hungary and the Arab Republic of Egypt. All told, the value of new greenfield FDI projects from China to all competing centers exceeded $52 billion in 2023, a threefold increase from the year before and a sevenfold rise from 2019 (figure 2.2). FIGURE 2.2 Value and number of announced greenfield FDI projects from China to selected manufacturing hubs, 2014-23  China’s 60,000 manufacturers are increasing FDI 50,000 to rival hubs to █ Egypt, Arab Rep. offset barriers to 40,000 █ Hungary China-sourced █ Indonesia goods... 30,000 $ millions █ Korea, Rep. 20,000 █ Thailand █ Mexico 10,000 █ Malaysia 0 █ Vietnam 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 ...a pattern that is 200 also reflected in 180 the number of 160 new projects in █ Egypt, Arab Rep. 140 these countries █ Hungary Project 120 █ Indonesia announcements, # 100 █ Korea,, Rep. 80 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 60 █ Thailand 40 █ Mexico 20 █ Malaysia 0 █ Vietnam Source: fDi Markets; The Financial Times. 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 The surge in China’s outbound FDI to these competing hubs appears to be focused on sectors that are politically sensitive in the ultimate destination country, often the United States or Europe. In 2023, companies in China invested more than $11 billion in computer manufacturing in other countries, 13 times more than they invested in 2022 and five times more than the annual average in the previous decade. The value of China’s FDI projects in motor vehicles and electrical equipment also soared (figure 2.3). The evidence supports the view that companies in China are relocating production to countries offering access to the US market, such as Mexico through the United States–Mexico–Canada Agreement. Such FDI relocations have raised concerns about near-shoring undermining the US manufacturing sector, and many political leaders are seeking restrictions (see, for instance, Office of Sherrod Brown [2024]). 38 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations These relocations are also consistent with a new approach to manufacturing and importing by some Western companies, called the China Plus One strategy. Under this approach, businesses mitigate risk by spreading their supply chain and manufacturing activities from China exclusively to include a third country. FIGURE 2.3 Value of announced greenfield FDI projects from China to other countries by sector, 2014–23, $ millions  China’s outward 30,000 FDI in sensitive sectors is rising 25,000 sharply to offset restrictions on 20,000 China-produced goods 15,000 10,000 █ Electrical equipment 5,000 █ Motor vehicles █ Computers, electronics 0 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: fDi Markets; The Financial Times. Note: Sensitive sectors vary by country but may include food and agricultural products, labor-intensive manufacturing, health care, and computer and other technology-focused industries. It is worth noting that not all trade and FDI are likely to be equally affected by economic fracturing. Much trade in basic consumer goods between FDI blocs, for example, may remain largely unaffected, and the same is likely to be true for FDI. Although more evidence will be needed, substantial shifts in patterns of FDI may be concentrated in sensitive sectors, with modest impacts in others. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 39 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations BOX 2.1 Is US FDI relocating to Mexico? From an FDI perspective, near-shoring would suggest that US number of M&A projects averaged 30 a year between 2018 and multinationals may see advantages in relocating their opera- 2020 but 57 a year between 2021 and 2023 (figure B2.1.2). tions from other countries into Mexico, potentially increasing A survey by the Bank of Mexico in July 2022 found that compe- FDI flows there. Mexico is uniquely positioned as a near-shoring tition between the United States and China was the top factor destination for FDI given its geographical proximity to the US (49.3 percent of respondents) behind the arrival of more foreign market. The United States and Mexico have participated in companies into Mexico that sought to benefit from proximity North American trade agreements since the mid-1990s, so to the United States (Banco de Mexico 2022). That survey also commercial and trade links between the two countries are ex- reported that 16 percent of companies with more than 100 tensive. Indeed, US FDI flows into Mexico rose from around $34 workers nationwide had benefited in some way from near-shor- billion in the five years from 2014 to 2018 to $45 billion in the ing over the preceding 12 months. The benefits resulted from 2019–23 period (figure B2.1.1). More recent data on mergers one or more of the following: increased FDI, increased demand and acquisitions (M&A), a type of FDI, tell a similar story. The from companies in the United States, companies that moved FIGURE B2.1.1 their operations to Mexico (near-shoring), or by other Mexican US FDI flows to Mexico, 2014–18 vs. 2019–23, companies benefiting from near-shoring. US$ millions Companies are increasingly seeking shorter, more robust US FDI to 50,000 supply chains while simultaneously side-stepping geopolitical Mexico has uncertainties, thus elevating Mexico as a favored manufacturing climbed in 40,000 recent years hub for the North American market. Citibanamex reported in 30,000 December 2022 of mounting evidence of firms relocating their production from Asia to Mexico, with major players like Boeing, 20,000 General Motors, Honda, Nucor, Oster, Samsung, Mattel, and 10,000 Black & Decker shifting more than $3 billion in annual produc- tion to Mexico (Citibanamex 2022). That report also indicated 0 that 61 percent of such near-shoring relocations are concen- 2014-2018 2019-2023 trated in Monterrey and Saltillo. Source: US Bureau of Economic Analysis. FIGURE B2.1.2 US mergers and acquisitions in Mexico, 2018–23, number of deals, by half years SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK US M&A activity 35 in Mexico has 30 been rising 25 20 15 10 5 0 2018-1H 2018-2H 2019-1H 2019-2H 2020-1H 2020-2H 2021-1H 2021-2H 2022-1H 2022-2H 2023-1H 2023-2H Source: Refinitiv.  40 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations BOX 2.2 Friend-shoring in India The ratio of FDI inflows to GDP in India reached a inflows, during April 2010–March 2017 to $301 peak of 3.6 percent in 2008 before declining to an billion, or 44 percent of total equity inflows, during average of around 1 percent in 2022 and 2023, April 2020–March 2024.a Reports have emerged according to World Bank data. Even so, Invest of multinational manufacturing companies relocat- India reported $71 billion in FDI flows into India in ing part of their production from China to India in fiscal year 2023/24. India launched its Make in India response to the China Plus One strategy, aimed initiative in 2014, aimed at establishing India as a at increasing the resilience of their supply chains, premier manufacturing destination, drawing on both especially for products manufactured in a single domestic and foreign investments. In that context, location. Apple, for example, is reported to have India has fostered a business-friendly climate with tripled its iPhone production in India in 2022, and increasingly simplified administrative procedures. it is expected to continue to increase its manufac- At the same time, India has been cautious about turing presence there (Capoot 2024; Atkins 2023). the acquisition of Indian firms by investors from Uniqlo is reportedly planning to shift production countries sharing a land border with India; such from China to India (and Southeast Asia) to reinforce investments now follow the government approval business resilience and leverage cost considera- route. tions (Arc Group 2024). Additionally, Hasbro and Ikea are also reported to be sourcing more from Friend-shoring trends present new FDI opportuni- India (Braw 2022; Arc Group 2024). It should be ties for India. Under the China Plus One strategy, noted that friend-shoring opportunities leading to companies have sought to diversify their manufac- FDI relocations are not limited to manufacturing and turing locations, increasingly favoring other coun- may also include back-office operations and other tries in Asia as their “Plus One.” Vietnam has been components of the production process classified as an especially important beneficiary of this trend, in services. part because of its preferential access to developed country markets through trade agreements. India, To bolster market access to developed countries, however, has also prospered, in part because of India has pursued and concluded trade agree- its electronics sector, where exports to the United ments, such as the India Australia Economic States have surged (Debroy and Sinha 2024). India Cooperation and Trade Agreement in 2022 and the is also benefitting from certain green technologies: Comprehensive Economic Partnership Agreement US imports of Indian solar panels and cells jumped with the United Arab Emirates in 2022. Further- SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK more than sevenfold in 2023 from the year before more, India is in negotiations with the European (Chu 2024). Union, the United Kingdom, and Gulf Cooperation Council countries. Indeed, India’s appeal as a manufacturing center is on the rise. Manufacturing FDI flows to India a. Department for Promotion of Industry and Internal Trade, FDI Statistics, https://dpiit.gov.in/publications/fdi-statistics. increased from $140 billion, or 42 percent of total 41 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations The shifting FDI landscape through the eyes of investment promotion agencies Investment promotion agencies (IPAs) are on the front lines of the competition for FDI. Virtually every country seeks capital from cross-border investors, aware that FDI can support economic growth, create jobs, and transfer technology. To that end, IPAs worldwide are in contact with thousands of potential investors each year, hoping to attract them to their countries, helping them navigate local conditions to set up operations, and providing investors already operating in their countries with “aftercare” services. During this process, IPAs learn what matters most to investors—and what discourages them. With that in mind, MIGA conducted a survey of IPAs, in collaboration with the secretariat of the World Association of Investment Promotion Agencies (WAIPA) (box 2.3). The goal was twofold: first, to understand IPAs’ opinions of the broader investment landscape and, second, to capture their views on the question at the heart of this report: Is geopolitical competition altering the investment environment? BOX 2.3 The MIGA-WAIPA Survey MIGA developed the IPA CEO Survey of Trends and Emerg- cally representative of all IPAs or of all FDI. Rather, its aim was ing Patterns in Foreign Direct Investment in early 2024; it was to capture the views of a range of IPAs, and the investors with administered during the first half of the year by WAIPA (here- whom they interact, on the current investment landscape. inafter called the MIGA-WAIPA Survey) with further follow-up We note that most IPAs meet regularly with a large number of from MIGA. WAIPA was created in 1995 by the United Nations international investors, based on their responses to a survey Trade and Development (UNCTAD) agency; its secretariat is question. We estimate that in each of the last two years, the in Geneva. WAIPA’s stated mission is “to network and build IPAs who responded to the survey met, in aggregate, with at relationships with Investment Promotion Agencies (IPAs) from least 20,000 investors annually. around the world, where they can share their experiences Developed (or high-income) countries accounted for around 40 and knowledge to enhance their investment promotion and SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK percent of respondents and developing countries for around 60 facilitation activities.” IPAs meet with large numbers of poten- percent. By region, 28 percent of the respondents came from tial investors (table B2.3.1). Depending on the question, the European and Central Asian countries, 22 percent from the survey asked IPAs to relay either their own views based on their Americas, 20 percent each from Sub-Saharan Africa and Asia, interactions with foreign investors, or those of their investors and 11 percent from the Middle East and North Africa (the total as expressed to them and as they understood them, on a wide does not equal 100 percent due to rounding). range of FDI-related topics.a We acknowledge that the regional response distribution may The survey was sent to approximately 150 IPAs; 50 returned have influenced the choice of geopolitical and economic risks the questionnaire. The survey was not intended to be statisti- in figure 2.4 (for example, Russia’s invasion of Ukraine was the TABLE B2.3.1 number one risk, and 28 percent of the respondents were from IPAs’ contacts with investors, per MIGA-WAIPA Survey Europe and Central Asia). But the makeup of responses, by Number of investors IPAs met with annually in 2022 and 2023 region, was not especially skewed (each major region repre- % respondents sented between 20 percent and 28 percent of all responses), Less than 200 17 and nonregional-specific risks, such as supply chain disruptions 200-499 31 and high interest rates, featured very prominently in the IPA 500-1,000 28 responses. More than 1,000 24 a. See appendix 1 for a complete list of questions in the MIGA-WAIPA Survey. 42 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Russia’s invasion of Ukraine is the number one risk, but supply chain disruptions also rank high The Russian invasion of Ukraine was ranked as the number one investment risk in 2022–23 by respondents to the MIGA-WAIPA Survey (26 percent), the most votes for any geopolitical and economic risk during that time. The invasion had its greatest impact on countries in the region, but it also had wider implications, disrupting global energy markets and food supplies and contributing to higher prices worldwide. Three other risks—the COVID-19 pandemic, conflict in the Middle East, and supply chain disruptions—received the second most votes, each ranked first by 13 percent of respondents. Although supply chain disruptions, which severely impacted the global economy between 2020 and 2022, were ranked first by a relatively small share of respondents, this masked an underlying trend: supply chain disruptions were labeled one of the top three risks by 53 percent of all IPAs, BOX 2.4 Ranking investment risks The current economic, political, and social environment is past—and for the next three years, 2024–26, based on their marked by interconnected hazards and compounding risks that outlook. Many of the risks (see tables B2.4.1 and B2.4.2) were threaten to roll back development gains and undermine efforts similar in the two time periods. to end extreme poverty and promote shared prosperity in a Importantly, we have chosen to focus not just on which risk was sustainable way.a The likelihood of what are sometimes called ranked number one most often by respondents but on the risks “poly-crises,” or compounding crises, increases as interacting that featured in the top three positions of the rankings (figure risks build on one another, resulting in impacts that greatly 2.4). This offers a broader perspective on the top issues that exceed the sum of each part. most concern IPAs. Survey respondents were asked to rank from 1 to 10 a list of geopolitical and economic crises based on their conversations a. “Global Crisis Risk Platform,” World Bank Group, https://www.worldbank. org/en/topic/fragilityconflictviolence/brief/global-crisis-risk-platform- with investors. Two time periods were surveyed: respondents gcrp#:~:text=The%20likelihood%20of%20polycrises%20or,the%20sum%20 were asked to rank risks for 2022–23—essentially the recent of%20each%20part. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK TABLE B2.4.1 TABLE B2.4.2 Geopolitical and economic risks, 2022–23, Geopolitical and economic risks, 2024–26, per MIGA-WAIPA Survey per MIGA-WAIPA Survey COVID pandemic Pronounced/persistent slowdown in China’s economy War in Ukraine Escalation of the war in Ukraine / regional spillover US-China political and trade tensions US-China geopolitical and trade tensions worsen War and armed conflicts in the Middle East Global geopolitical fragmentation High interest rates / cost of capital War and armed conflicts in the Middle East expand Supply chain disruptions Interest rates / cost of capital remain high Cost-of-living crisis / inflation Supply chain disruptions resume Concerns around sovereign default / debt distress High inflation persists or returns Financial market turmoil Sovereign default / debt distress in countries of operation / investment Concerns around political/civil unrest New armed conflicts with global implications Political/civil unrest in important destination countries 43 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations FIGURE 2.4 Geopolitical/economic risks of most concern, 2022–23 and 2024–26, percent of respondents ranking in top three War in Ukraine and 60 supply chains were big risks in 50 2022–23... ...and remained so 40 looking to 2024–26 30 2022–23 █ All countries 20 █ Developing countries 2024–26 10 █ All countries █ Developing countries 0 War in Ukraine Supply chain High interest US-China Source: MIGA-WAIPA Survey. disruptions rates / cost of capital political/trade divide the highest number in the first three positions, in aggregate, for any riskLorem ipsum (figure 2.4). This suggests that while supply chain disruptions were not the single greatest risk for most IPAs, they were a major concern for the majority. Indeed, supply chain issues will continue to be of deep concern in 2024-26, especially for developing countries, with a majority ranking them a top-three risk. Another risk that features prominently is high interest rates and the cost of capital (figure 2.4). Although central banks were starting to reduce interest rates in 2024 after a period of elevated inflation, many respondents, especially those in developing countries, remain concerned that high interest rates will curb FDI flows in the coming years. Looking ahead to 2024–26, another issue looms: around 45 percent of all respondents listed a pronounced slowdown in China’s economy, the world’s second largest, as a top-three investment risk. Real GDP in China expanded by 5.2 percent in 2023, but the World Bank, in its June 2024 Global Economic Prospects report, expects China’s GDP growth to slow to 4.8 percent in 2024 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK and to 4.1 percent in 2025. FIGURE 2.5 Expected change in FDI, 2024–26, compared with prior three years, percent of respondents Most respondents 80 expect FDI to 70 increase over 60 the next three 50 years 40 30 20 █ All countries 10 █ Developing countries 0 Source: MIGA-WAIPA Survey. Increase Decrease Unchanged 44 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Outlook for FDI Despite the geopolitical and economic risks to FDI, around three-quarters of all IPAs, and about the same number of those in developing countries, expect direct investment inflows to their countries to rise during the next three years compared with the prior three (figure 2.5). This should not be a surprise; the global economy is expected to grow, if slowly, in coming years and FDI flows are heavily influenced by global GDP growth. IPAs can also be expected to take a positive view of future business prospects. It is perhaps more notable that nearly 20 percent of all IPAs, and a similar share of those in developing countries, acknowledged that they expect FDI inflows to decline over the next three years compared with the prior three. The reasons for this are not clear; the survey did not explore this issue, but insights into the sectoral composition of FDI may shed some light. Nearly 20 percent of respondents, for example, said they expected a decline in oil and gas investment over the next three years, the largest decline in any of the eight industries included in the survey. This could explain the pessimistic view of some IPAs, particularly those in oil and gas-producing and exporting countries. Separately, the latest World Bank Multinational Enterprise Pulse Survey shows that uncertainty among multinationals’ affiliates about their expected investments remained high, particularly in the Middle East and North Africa and Sub-Saharan Africa.1 Optimistically, most IPAs expect to attract a share of the increasing sums of cross-border information and communications technology (ICT) investment that is flooding the global economy (figure 2.6). As noted in chapter 1, sectoral greenfield FDI flows show substantial gains in international investment in ICT in recent years. IPAs expect that to continue: just over 80 percent of developing country respondents anticipate an increase in communications and digital FDI in their country over the next three years compared with the last three. FIGURE 2.6 Outlook for FDI by sector, developing countries, 2024–26, percent of respondents SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 0 10 20 30 40 50 60 70 80 90 Developing Agriculture, forestry and mining country IPAs are very confident Oil and natural gas about rising ICT Manufacturing investment Utilities Transport/logistics Communications/digital █ Increase █ Decrease Financial services █ Unchanged Other services Source: MIGA-WAIPA Survey. Note: ICT = information and communication technology; IPA = investment promotion agency. 1 The latest survey was conducted by the World Bank between January and June 2023 and targeted senior executives at over 1,000 multinational affiliates across all developing regions. 45 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Around three-quarters of all IPAs, and a like number of those in developing countries, also expect an increase in the next three years in manufacturing FDI, which has been the lifeblood of international investment for decades, even though services FDI has become more important in recent years. Consistent with that evolving trend, around three-quarters of all IPAs, and a similar number in developing countries, also expect an increase in the next three years in transport and logistics FDI, perhaps to support the rising levels of infrastructure investment in many countries. India, for example, released a budget in February 2024 that allocated nearly $134 billion in government spending on infrastructure, 11 percent more than the year before. Although governments are spending more on infrastructure, private capital will also be needed to meet targets. The Global Infrastructure Hub, a G-20 initiative that is merging into the World Bank Group’s infrastructure facility, forecast that global spending on basic infrastructure—transport, power, water, and communications—will total $79 trillion from 2016 through 2040, while the actual investment need is $94 trillion (GI Hub 2017). IPAs clearly are targeting a share of this infrastructure investment. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 46 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Outlook for friend-shoring, near-shoring, and reshoring As discussed earlier, FDI relocations and the underlying risks to supply chains have many causes: geopolitical competition between major countries, lessons learned from COVID-19 logistics disruptions, and a desire by some countries to be more self-sufficient in certain sectors and less reliant on others. The MIGA-WAIPA Survey provides additional evidence on the importance of FDI relocations, with nearly 80 percent of all IPAs, and almost 90 percent of those in developing countries, expressing the view that friend-shoring would be very important or moderately important during the next three years (figure 2.7). A similar percentage of all IPAs, around 85 percent, expressed the same view about near-shoring (figure 2.8). A smaller share of respondents thought reshoring, or the relocation of investment and production from a foreign country back home, would become significant. FIGURE 2.7 Importance of friend-shoring to foreign investors, 2024–26, percent of respondents A large share of 50 IPAs expects friend-shoring to 40 become a 30 significant trend... 20 10 █ All countries █ Developing countries 0 Very important Moderately important Somewhat important Not important FIGURE 2.8 Importance of near-shoring to foreign investors, 2024–26, percent of respondents ...and even more 50 see near-shoring as a major 40 development 30 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 20 █ All countries 10 █ Developing countries 0 Source: MIGA-WAIPA Survey. Very important Moderately important Somewhat important Not important Note: IPA = investment promotion agency. 47 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Impacts on FDI relocations Friend-shoring Global development agencies and financial institutions, including the World Bank and the IMF, worry that friend-shoring could lead to substantial reductions in FDI to some countries.2 But when asked about friend-shoring in the MIGA-WAIPA Survey, just over three-quarters of all respondents, and 85 percent of developing country IPAs, said they expect friend-shoring to have strongly positive or positive effects on their country during the next three years (figure 2.9). This may be an overly optimistic reading, but it reflects the fact that many respondents were close geopolitically (and in some cases geographically) to the US market. It may also reflect an optimism inherent in IPA views on the attractiveness of their countries to foreign investors. Only around 3 percent of all respondents, and 5 percent of developing countries, expected to be negatively affected by friend- shoring in the coming years. FIGURE 2.9 Impact of friend-shoring on FDI relocations, percent of respondents Most IPAs expect 80 friend-shoring to 70 have positive 60 effects on FDI 50 40 30 20 █ All countries 10 █ Developing countries 0 Strongly positively affected Positively affected Negatively affected No change in investment (e.g., significant increase (e.g., modest increase (e.g., modest divestment/ due to friend-shoring Source: MIGA-WAIPA Survey. in FDI inflows) in FDI inflows) decrease in FDI inflows) Note: IPA = investment promotion agency. Indeed, the reason most cited by all IPAs (71 percent of respondents) for why they expected SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK to benefit from friend-shoring was strategic/political compatibility with FDI source countries (figure 2.10). For developing countries, the most cited reason was supply chain integration with multinational enterprises (77 percent). This suggests that IPAs are already seeing FDI relocations consistent with friend-shoring (that is, political alignment with source countries). Another frequently cited reason is less business focused but still a significant one for IPAs: cultural compatibility with FDI source countries (63 percent), a sign that intangibles can sometimes be important to investment relationships. A survey of foreign investors in Bangladesh also highlighted political congruence with FDI home countries—but also the importance of labor costs and preferential market access (box 2.5). 2 “Several emerging market and developing economies are highly vulnerable to FDI relocation, given their reliance on FDI from geopolitically distant countries. In the long term, FDI fragmentation arising from the emergence of geopolitical blocs can generate large output losses. These losses may be especially severe for emerging market and developing economies facing heightened restrictions from advanced economies, which are their major sources of FDI” (IMF 2023c, ch. 4). 48 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations BOX 2.5 Friend-shoring opportunities: The views of foreign investors in Bangladesh3 Even prior to the recent political transition, foreign direct invest- FIGURE B2.5.1 ment (FDI) flows in Bangladesh had been on a declining trend, How well is Bangladesh positioned to take advantage of friend-shoring? but with year-to-year fluctuations. Expressed as a ratio to GDP, Percent of respondents FDI flows have been below 1 percent in recent years, registering 0.4 percent in 2022, compared with 1.4 percent for lower-mid- 9% 41% dle-income countries and 1.3 percent for South Asia. The No response Somewhat well current environment is likely to lead to a wait-and-see approach positioned to take advantage by foreign investors to assess the commitment of interim and 20% of friend-shoring future governments to structural reforms that tackle long-stand- Not well positioned to ing challenges and return the country to political stability. take advantage 30% During March–May 2024, the World Bank Group conducted of friend-shoring Well positioned to take advantage a survey of foreign investors operating in Bangladesh with a of friend-shoring view toward identifying the principal FDI constraints as well as Source: Bangladesh FDI survey. potential opportunities, including in the context of near-shoring and friend-shoring. Given the high share of reinvested earnings TABLE B2.5.1 in FDI inflows (74 percent in 2023), a survey of foreign investors What are the primary factors that place Bangladesh in a already in Bangladesh provided a good reflection of the con- favorable or somewhat favorable position to capitalize on friend-shoring? straints and opportunities arising from friend-shoring, based on Number of responses for the topmost factor responses from 176 companies. Favorable labor costs 45 Foreign investors currently operating in Bangladesh held Geopolitical congruence with key home countries of foreign 23 investors a favorable view of the country’s potential to capitalize on Preferential access to international markets 13 friend-shoring opportunities. Close to three-quarters of Access to specialized skills 11 respondents indicated that Bangladesh is well positioned or Cultural compatibility 9 somewhat well positioned to take advantage of friend-shoring opportunities (figure B2.5.1). For friend-shoring, FDI relocating Supply chain integration 9 to Bangladesh would be more likely to take place if there is Favorable regulatory framework for foreign direct investment 9 preferential market access for exports to the foreign investor’s Access to energy and/or favorable energy costs 4 home country or to other markets the investor seeks to serve. Time zone advantages 3 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Source: Bangladesh FDI survey. The primary factors that place Bangladesh in a favorable or somewhat favorable position to capitalize on friend-shoring TABLE B2.5.2 opportunities included its competitive labor costs and geopolit- What measures would promote friend-shoring in Bangladesh? ical alignment, as well as the advantage of preferential access Number of responses for the topmost factor to international markets (table B2.5.1). Competitive labor costs Addressing bureaucratic/governance challenges 44 were also viewed by foreign investors as a key determinant of Geopolitical alliances with countries that are important sources 40 FDI into Bangladesh beyond friend-shoring. of foreign direct investment Preferential export market access / favorable trade policy with 33 Tackling bureaucratic and governance issues, forging allianc- countries that are important sources of foreign direct investment es with key FDI source countries, and ensuring preferential Investment incentives favoring foreign direct investment from 26 export market access were identified by the responding firms countries with geopolitical alliances as key elements in promoting Bangladesh as a friend-shoring Strengthening regulatory frameworks for foreign direct 23 destination (table B2.5.2). The first measure echoes opinions on investment overcoming barriers for all types of FDI Source: Bangladesh FDI survey. 3 Based on a survey of foreign investors in Bangladesh for the forthcoming World Bank Group Bangladesh Country Private Sector Diagnostic. 49 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Whatever the IPAs stated reasons for believing friend-shoring—and near-shoring—would have positive effects on their countries, their views must be too optimistic. Regarding current investment, shifts in FDI from one host country to another must, by definition, be a zero-sum proposition: every dollar of existing FDI that newly enters one country must be diverted from another. All or most IPAs, therefore, cannot benefit from FDI relocations driven by friend-shoring or near-shoring. That so many IPAs see a rosy outcome from FDI relocations suggests that a painful surprise may await some or many of them. IPAs should be carefully and realistically assessing the outlook for FDI relocations and preparing themselves for unexpected outcomes. The best course of action is likely to be refocusing on the long-standing determinants of FDI: a reasonable regulatory environment, access to skilled labor, moderate taxation, and good infrastructure, among other factors. These are necessary conditions to increase attractiveness as an FDI destination, but in a world where geopolitical considerations drive friend-shoring trends, these may no longer be sufficient. FIGURE 2.10 Factors driving friend-shoring, percent of respondents 0 10 20 30 40 50 60 70 80 Strategic Strategic/political compatibility with FDI source countries compatibility and supply-chain Cultural compatibility with FDI source countries integration underpin Supply chain integration with multinational companies friend-shoring from FDI source countries Safety/security of operations Compatible climate and sustainability policies/standards Time zone advantages with FDI source countries Compatible environmental, social and governance (ESG) standards Effects of source-country environmental policies SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK █ All countries (e.g., the EU’s Carbon-Adjustment Border Mechanism, the US Inflation Reduction Act, etc.) █ Developing countries Effects of friend-shoring have not been observed in my country/jurisdiction Source: MIGA-WAIPA Survey. Respondents believe manufacturing will most benefit from friend-shoring, with nearly 73 percent of all respondents, and a similar number of developing country IPAs, expecting the industry to be either strongly positively affected or positively affected (figure 2.11). Within manufacturing, pharmaceuticals and electrical equipment were most often cited, by around 65 percent and 61 percent of respondents from both groups, respectively. This is not surprising given the complexity of international pharmaceutical supply chains, comprising a diverse array of producers, suppliers, and distributors, making them vulnerable to disturbances, with negative effects on public health. Electrical equipment supply chains, deemed stable in the past, have been facing new challenges, such as critical material scarcities, disruptions in shipping, and rising expenses. Geopolitical concerns have exacerbated the situation, given that China is a key supplier of numerous components within the electrical supply chain (Knox 2023). 50 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Within the service sector, around 62 percent of all respondents, and the same number of developing country IPAs, expected financial services to be strongly positively affected or positively affected by friend-shoring, the most of any service sector. It is possible that financial services friend-shoring will be triggered by a “follow the client” approach, with FDI relocations in manufacturing and other sectors giving rise to FDI shifts in financial services to meet client needs in the new locations, for example, in terms of working capital or arrangements for trade finance. Because financial systems vary across countries, with differing regulations, payment infrastructures, and banking networks, physical presence is often necessary. FIGURE 2.11 Sectors most likely to be affected by friend-shoring during the next three years, percent of all respondents 0 10 20 30 40 50 60 Transport, Utilities communications Transport and pharmaceuti- cals are expected Communications to benefit Agriculture, forestry and mining significantly from friend-shoring Oil and natural gas Services Financial services Manufacturing (of which) • Motor vehicles, trailers, etc. • Electrical equipment • Computer, electronic, etc. • Food and beverages • Wearing apparel and textiles • Machinery & equipment • Coke & refined petroleum prods. • Chemicals • Fabricated metals █ Strongly positively SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK affected • Basic metals █ Positively affected • Rubber █ Negatively affected • Other non-metallic mineral prods. █ Strongly negatively affected • Pharmaceuticals • Wood Source: MIGA-WAIPA Survey. Transport and communications also featured prominently as services sectors that will be most positively affected by friend-shoring over the next three years (figure 2.11). Each was cited by almost 60 percent of all respondents and by a similar number of developing countries. FDI relocations in manufacturing and other sectors are likely to have indirect effects on these two sectors as they seek to recalibrate and align their FDI presence. Overall, only a minority of respondents—almost always less than 10 percent—believed that friend-shoring will negatively or strongly negatively affect the listed sectors. 51 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Near-shoring IPAs were somewhat less optimistic about near-shoring than friend-shoring, with around two- thirds of all respondents, and a like share of developing countries, believing it would be strongly positive or positive, compared with around 80 percent who expected positive outcomes from friend-shoring. Only around 5 percent of both groups expected near-shoring to have negative consequences (figure 2.12). The reason most often cited for the positive effects was supply chain integration with multinational companies from FDI source countries (cited by 66 percent of all respondents), suggesting that IPAs expect companies to relocate in their countries to be closer to final markets (figure 2.13). Developing countries had slightly different views, listing preferential trade agreements and transport distance (73 percent each) as the main reasons they expected to benefit from near-shoring. Transport distance, of course, is at the heart of policies focused on bringing FDI closer to home and securing supply chains. Other factors cited that support near- shoring included time-zone advantages and government incentives. The sectoral implications of near-shoring—that is, which industries are likely to be the most affected—were similar to friend-shoring, although manufacturing was cited more often as the top industry by developing countries (38 percent) than by all countries (27 percent). Unsurprisingly, few high-income countries viewed manufacturing as likely to benefit from near-shoring (8 percent), FIGURE 2.12 Impact of near-shoring on FDI relocations, percent of respondents A majority of 50 IPAs expect near-shoring to 40 benefit FDI 30 20 10 █ All countries SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK █ Developing countries 0 Strongly positively affected Positively affected No change in investment Negatively affected (e.g., significant increase (e.g., modest increase due to near-shoring (e.g., modest divestment/ Source: MIGA-WAIPA Survey. in FDI inflows) in FDI inflows) decrease in FDI inflows) FIGURE 2.13 Factors driving near-shoring, percent of respondents 0 10 20 30 40 50 60 70 80 Supply chain Distance/connectivity in terms of transport integration and shorter transport Free/preferential trade agreements times support Time zone advantages near-shoring Supply chain integration with multinational companies from FDI source countries Compatible climate and sustainability policies/standards Compatible environmental, social and governance (ESG) standards Government incentives █ All countries Effects of source-country environmental policies (e.g., the EU’s Carbon-Adjustment Border Mechanism, US Inflation Reduction Act, etc.) █ Developing countries Effects of near-shoring have not been observed in my country/jurisdiction Source: MIGA-WAIPA Survey. 52 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations as developed countries would not typically attract FDI as part of a move to near-shoring. Within manufacturing, all IPAs cited the sensitive sectors of pharmaceuticals and electrical equipment as most likely to be positively affected, although developing countries added computers and related products to the list. As was noted in chapter 1, developing countries, especially in Asia, have been major recipients of ICT FDI in recent years, and IPAs clearly expect this to continue. Reshoring Reshoring, the third investment trend considered in the survey, predictably generated different results from friend-shoring and near-shoring. Reshoring involves moving investment or production back to source countries, often from developing countries to high-income economies. Half of all survey respondents, and half of developing country IPAs, expected no impact on FDI flows from reshoring, likely reflecting the belief that their countries’ location-specific advantages were sufficiently strong to overcome strategic considerations driving reshoring (figure 2.14). Only around a third of respondents said they expected to be strongly positively affected or positively affected by reshoring during the next three years, compared with upward of 70–80 percent each for friend- shoring and near-shoring. Most of those expecting positive changes in FDI inflows from reshoring were high-income economies, but around 25 percent of respondents were developing countries, suggesting that FDI relocation driven by reshoring is not confined to developed economies—that is, FDI may shift from one developing country to another. Significantly, and perhaps surprisingly, only 25 percent of developing countries said they expect to be strongly negatively affected or negatively affected by reshoring. This may be further evidence that some IPAs are taking a complacent view of the potential impact of FDI relocations, including reshoring. FIGURE 2.14 Impact of reshoring on FDI relocations, percent of respondents Around half of 50 developing 40 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK countries expect no FDI impact from 30 reshoring 20 10 █ All countries █ Developing countries 0 Strongly positively Positively affected No change in FDI due to Negatively affected Strongly negatively affected (e.g., significant (e.g., modest increase in reshoring (e.g., modest affected (e.g., significant increase in FDI inflows) FDI inflows) divestment/decrease in divestment/decrease in Source: MIGA-WAIPA Survey. FDI inflows) FDI inflows) Over the next few years, concerns about geopolitical and trade tensions (cited by just under 60 percent of all respondents and developing country IPAs) and policies in FDI source countries encouraging reshoring (cited by a similar number of both groups) were the main factors driving reshoring (figure 2.15). This is consistent with the literature and reinforces the view that FDI relocations back to home countries would be driven by supply chain resilience considerations that became apparent during the pandemic but have been exacerbated by trade tensions and national security concerns for select industries. Host-country factors, such as access to markets and skills, did not feature prominently, suggesting that the ability of host countries to influence this type of FDI relocation is limited. 53 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations FIGURE 2.15 Factors driving reshoring, percent of respondents 0 10 20 30 40 50 60 70 Geopolitical Policies in FDI source countries encouraging reshoring issues and source- Concerns about geo-political and trade tensions country policies are driving National security considerations that support reshoring in strategic/critical sectors reshoring Supply chain bottlenecks and other disruptions Rising production costs in FDI host countries Rising transportation costs Better access to specialized skills in FDI source countries Effects of source-country environmental policies (e.g., the EU’s Carbon-Adjustment Border Mechanism, US Inflation Reduction Act, etc.) Ability to serve consumers in FDI host █ All countries countries from FDI source countries via trade █ Developing countries Political stability in FDI source countries Other (please specify) Source: MIGA-WAIPA Survey Import substitution with domestic production Consistent with FDI relocations driving near-shoring was the view expressed by around two-thirds of all respondents, and 77 percent of developing countries, that governments are adopting policies aimed at shifting the supply of products in critical or priority sectors from imports to domestic production (figure 2.16). The latest Multinational Enterprise Pulse Survey found qualitatively similar results. Over 70 percent of multinationals with supply issues switched to new domestic or regional suppliers. Over half of the multinational enterprises said their parent companies plan to invest more in lower-cost countries soon. There is some evidence that this shift is already happening in the United States, especially in the technology sectors but also in other strategic industries, such as metals. Through the US SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK CHIPS and Science Act, companies have announced nearly $50 billion in additional investments in US semiconductor manufacturing (The White House 2022). Based on survey responses, the top sectors in which FDI is substituting for imports are those related to health (64 percent of all respondents and 73 percent of developing countries), ICT and digital technologies (56 percent and 68 percent, respectively), and sectors related to food security (54 percent and 59 percent) (figure 2.17). FIGURE 2.16 Expected shift from imports to domestic production in priority areas, next three years, percent of respondents Countries are 90 expected to shift 80 from imports to 70 domestic 60 production in key 50 sectors 40 30 20 █ All countries 10 █ Developing countries 0 Source: MIGA-WAIPA Survey. Yes No Don’t know 54 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations FIGURE 2.17 Sectors in which FDI is expected to substitute for imports, percent of respondents 0 10 20 30 40 50 60 70 80 Health, ICT/digital, Food security and food security (e.g., agribusiness, fertilizers) are priority sectors Health (e.g., vaccine production, pharmaceuticals, pharmaceutical ingredients) Critical raw materials (e.g., cobalt, lithium, aluminum) Semiconductors ICT/digital technologies █ All countries None of the above █ Developing countries Other (please specify) Source: MIGA-WAIPA Survey. The importance of sectors related to health is likely an outgrowth of COVID-19 and limited access to vaccines during the early stages of the pandemic. When food commodity prices jumped in recent years, either because of weather or climate events or from geopolitical causes negatively affecting food-related trade and food supplies, food security became a priority. ICT and digital technologies, such as semiconductors and chip manufacturing, are considered critical because they are used in a wide range of electronic devices. Lack of digital delivery of services also became an obstacle to responding to the pandemic. As a result, governments are seeking to gain greater control over production, encouraging domestic investment and reshoring over imports. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 55 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations Conclusion Trade tensions, supply chain disruptions during and after the COVID-19 pandemic, transportation challenges because of conflicts, and policies aimed at encouraging investment at home are increasingly shaping the FDI landscape. While trade relations and supply chains have traditionally been the focus of research on near-shoring, friend-shoring, and reshoring, it is becoming clear that FDI flows are increasingly influenced by these developments. (See appendix 2 for more on this.) In response, multinational enterprises are reevaluating their strategies, relocating production to countries that are either closer to home or to ultimate destinations of their products, or to those that are geopolitically aligned. These trends are driven by the desire for more resilient and secure supply chains and by perceptions of rising trade tensions. Of course, cost considerations, traditional FDI location advantages, security factors, trade openness, and the ability to access final markets through preferential trade agreements remain important FDI determinants. Multinational enterprises unquestionably are responding to near-shoring and friend-shoring considerations. Increasingly, businesses in China, concerned about barriers in Western economies to their exports, are concentrating outward investment in third-country manufacturing hubs such as Malaysia, Mexico, and Vietnam, which are thought to have more reliable access to the United States and Europe. This accounts for the large increase in outward Chinese FDI to these economies. Much of that growth has been in politically sensitive sectors such as computers, electronics, and motor vehicles. The MIGA-WAIPA Survey of IPAs, organizations that regularly engage with foreign investors and are thus attuned to their plans and evolving challenges, has confirmed the significant risks posed by supply chain disruptions. Nearly 55 percent of the IPAs identified supply chain disruptions as one of the top three risks to FDI. Even so, IPAs are optimistic about the overall direction of FDI, with over three-quarters of these agencies expecting FDI flows into their countries to increase over the next three years compared with the previous three. All main sectors are expected to see SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK increases except agriculture, forestry and mining, and oil and gas, with IPAs being especially bullish on manufacturing, communications and digital services, and transport and logistics. Almost 80 percent of IPAs surveyed, and nearly 90 percent of those in developing countries, believe friend-shoring will be a significant trend over the next three years. Manufacturing is the sector expected to be most positively affected by friend-shoring, according to over 70 percent of IPA respondents. Within manufacturing, pharmaceuticals and electrical equipment are likely to benefit the most from friend-shoring. Strategic and political compatibility with the main source countries and integration of supply chains underpin the positive friend-shoring benefits. Similar observations were made regarding near-shoring, where the integration of supply chains and geographical distance/connectivity emerged as the primary drivers of this trend. The industries poised to gain from near-shoring mirror those expected to benefit from friend-shoring. Survey respondents expect reshoring to be a less significant investment trend. The main factors influencing reshoring are thought to be policies in the countries where the FDI originates, along with geopolitical and trade frictions, and considerations of national security. About a third of survey respondents expect reshoring to positively affect future investment flows, whereas most IPAs foresee no change or negative outcomes. Consistent with the concept of reshoring, around two- 56 © MIGA, 2024 Chapter 2 Near-shoring, friend-shoring, reshoring and FDI relocations thirds of IPAs observe that countries are implementing policies aimed at transitioning the supply of essential or critical products in priority sectors from imports to domestic production. The sectors believed to be most impacted by this shift are those related to health/pharmaceuticals, food security, and ICT/digital technologies. Most of the IPAs surveyed believe that both friend-shoring and near-shoring will offer opportunities to draw in FDI. It is important to note that several of the responding IPAs were from countries within the US orbit, which may lead to an overly optimistic outlook. But even for these countries, other factors could influence FDI relocation decisions. Essentially, FDI relocations are a zero-sum game where not all countries can benefit simultaneously, with those that successfully attract the relocating investment emerging as the winners. To this end, domestic policy reforms that foster a favorable investment climate, as well as preferential trade agreements, can contribute to the likelihood of attracting FDI seeking to relocate. In summary, the FDI landscape is expected to undergo a transformation owing to investment relocations driven by near-shoring and friend-shoring. IPAs view near-shoring and friend-shoring as beneficial, although the gains are likely to be more targeted than many IPAs are expecting. In contrast, reshoring is viewed as a distinct phenomenon influenced by FDI source-country domestic policies and factors that are beyond the influence of IPAs. The potential impact of these shifts on FDI could be significant, altering not just the geographical distribution of FDI and supply chains but also the wider geopolitical scene. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 57 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 58 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty Key messages  A very small—and declining—portion of  Some EMDEs stand to benefit from the new foreign direct investment (FDI) to emerging FDI relocation trends, but others will not. For markets and developing economies (EMDEs) the latter, an investment climate conducive is covered by political risk insurance (PRI), to FDI will help to preserve, and possibly yet political risks abound and have intensified increase, access to the types of investment in recent years. Although higher in absolute that are less susceptible to near-shoring, terms, the portion of FDI in low- and lower- friend-shoring, and reshoring. Political risk middle-income countries covered by political insurance can help support FDI in these risk insurance is also declining. Greater countries. investor awareness of how these risks can be insured, as well as new products tailored to  While PRI cover has yet to rebound to the investor needs, including in the context of the highs of the past decade, and even declined green transition, can support FDI, especially somewhat in 2023, multilateral providers have in challenging environments. seen a huge jump in issuance, albeit from a low initial base. They may be particularly well  Adverse, unclear, and nontransparent positioned to address political risks because regulations are considered the most of their perceived neutrality and the ability significant political risks in EMDEs, followed to leverage their convening power to de- by war, political unrest, and transfer and escalate disputes before they escalate into convertibility restrictions. Other constraints to claims. FDI in EMDEs pertain to access to financing, physical infrastructure, and weak domestic  The ratio of PRI issuance to FDI is environments. significantly higher for low- and lower-middle- income economies, compared with upper-  As the FDI landscape changes in response middle-income countries. For low-income to near-shoring and friend-shoring, and as economies, PRI issuance has been on an upward trend in terms of value, with year-to- SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK geopolitical alliances outside the control of foreign investors begin to drive location year fluctuations reflecting the perceptions of decisions, political risks have become even more significant political risks compared with more relevant. Political risk insurance offers other income groups. an important mitigant in that context. 59 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty Overview Political risk, shown in the literature to have a negative effect on FDI,1 has consistently ranked as a top constraint for FDI flows into developing countries.2 Multinational enterprises relocating across emerging markets in response to near-shoring and friend-shoring, among other reasons, may well encounter political risks and security challenges. Selecting FDI locations in response to near- shoring and friend-shoring (along with traditional factors) is no guarantee that political risks will not be present or will not materialize. Consideration should also be given to political risks arising from shifts in geopolitical alliances over time. One effective strategy to mitigate these risks, particularly those related to geopolitical misalignment and political instability, is political risk insurance. Applicable to both greenfield and brownfield projects, PRI can be an important mitigant when geopolitical alliances shift over time, or when FDI relocations take place in destinations that make sense from geographic and geopolitical perspectives but require mitigation against political risks. The 2024 MIGA-WAIPA FDI survey revealed an environment in which most respondents consider themselves attractive destinations for FDI relocations driven by near-shoring and friend-shoring. Given the exogenous geographic and geopolitical determinants of FDI relocations, traditional instruments to enhance FDI attractiveness may be insufficient. Moreover, countries that do not benefit from FDI relocations may need to pay particular attention to their investment climate and regulatory framework, including their implementation, to boost their attractiveness to FDI, and even advocate the use of PRI for potential foreign investors to mitigate political risks. This chapter begins by discussing constraints to FDI, including emerging risks; companies facing high levels of geopolitical risk tend to invest less, which has negative impacts on growth (Caldara and Iacoviello 2022). The chapter then takes stock of recent developments in PRI, a specialized line of coverage that not only offers compensation for claims but also supports investors in securing financing, potentially with improved conditions such as longer loan durations and larger loan amounts. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 1 See, for example, Busse and Hefeker (2007) and Echandi, Nimac, and Chun (2019). 2 MIGA, World Investment and Political Risk, various issues. 60 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty Political risks and constraints to foreign direct investment The aftermath of COVID-19 has ushered in a new era of unpredictability and instability, with profound short- and long-term implications. Societal unrest, a growing number of interstate conflicts, sovereign debt burdens, and increasingly severe climate change events are giving rise to increased uncertainty and volatility. In that context, political risks, broadly defined as the probability of disruption of the operations of companies by political forces and events, whether they occur in host countries or result from changes in the international environment (MIGA 2012), remain prominent in foreign investor perceptions. In particular: (i) Russia’s invasion of Ukraine and elevated conflict risk in the region has raised the profile of political risks in connection with unanticipated events. Select Berne Union (BU) members have identified this risk as a geopolitical development with the biggest negative impact over the past two years.3 This protracted conflict, now in its third year, has had significant knock-on effects on energy, food security, supply chains, inflation, and macroeconomic stability, affecting countries worldwide. Such events are not easily predicted and can manifest themselves unexpectedly in any region of the world. (ii) The COVID-19 pandemic gave rise to force majeure events for several off-takers— mostly energy utility state-owned enterprises that historically have been operating with losses and relying on governments for financial support. The competing demands on governments raised by the impact of the pandemic meant that resources to support these enterprises were not always forthcoming, leading to force majeure events or significant delays in payments. Such events can lead to international arbitration and potentially to awards against the host country. (iii) Oil, gas, and mining contract renegotiations in resource-rich economies have been a persistent political risk under the umbrella of resource nationalism. New governments SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK may consider contract renegotiations (Berger 2021; Cotula 2019) or “rebalancing” as a way of extracting more benefits for the country from foreign investors. Mining remains a sensitive sector. (iv) Macroeconomic uncertainty and new challenges emerged as economies rebounded from the pandemic. The Institute of International Finance, an industry group, reported ballooning debt for EMDEs, topping $105 trillion in the first quarter of 2024 (Tiftik, Mahmood, and Aycock 2024), along with sovereign debt defaults in several developing countries.4 With rising and “sticky” inflation across the world leading to still-tight monetary policies, EMDEs, despite better-than-expected growth performances overall, continue to face pressure in terms of financing costs, which has resulted in sovereign rating downgrades in many cases. Foreign exchange shortages have affected several countries (Ethiopia, Nigeria) and have emerged in new ones (Bangladesh). Overall, the macroeconomic environment remains uncertain and volatile, with select BU members 3 MIGA and the Berne Union contacted several PRI providers in early 2024 to capture their assessment of the PRI market during the last few years and their outlook for the medium term. 4 Argentina, Ecuador, Ethiopia, Ghana, Lebanon, Sri Lanka, Suriname, Ukraine, and Zambia. 61 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty noting that sovereign defaults and debt distress have had significant negative impacts over the past two years. Furthermore, select BU members have expressed the view that sovereign defaults will remain a political risk of considerable concern for their clients over the next two years. Transfer and convertibility restrictions are also viewed as an important concern for clients. (v) Geopolitical tensions, interstate conflict, contested elections, and political violence have characterized the economic recovery from the pandemic. A record number of elections globally in 2024 (WEF 2023), and their aftermath, underscore the likelihood of elevated domestic tensions and the potential for political violence; 64 countries with a combined population of more than 4 billion people, including India, Indonesia, and the United States, have had or will have elections in 2024 (Verisk Maplecroft 2024). Elections in EMDEs often are accompanied by civil disturbances, raising the risk of political violence and disruption of business operations. Interstate conflict, civil war, and insurgency remain growing issues across the world. Select BU members view war and interstate conflict as the political risk that had the biggest negative impact over the past two years, and as the political risk of top concern for their clients over the next two years. (vi) Climate risks (physical and transition risks) are an increasing concern for businesses (Zurich 2024), and if unabated are expected to have significant adverse effects on poverty reduction (World Bank 2024c). Climate change continues to manifest, with 2023 the hottest year on record, with average global temperatures reaching 1.48°C above preindustrial levels (World Bank 2024c). Verisk Maplecroft’s Extreme High Temperatures dataset, which measures the frequency with which air temperatures are set to exceed 35°C, indicates that some 60 of the 770 cities in the world with a population over 1 million are rated high risk or very high risk on that index. The World Economic Forum’s Global Risks Report 2024 ranks extreme weather as one of the top two risks most likely to present a material crisis on a global scale in the short term (next two years) and SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK the top risk in the long term (next 10 years) (WEF 2024). The transition to low-carbon economies and the implementation of new technologies place increased emphasis on critical minerals and metals (Partridge 2024) and on the need to mitigate political risks related to their extraction. Decarbonization efforts would be expected to increase demand for guarantees for renewable energy projects. Support for climate finance projects, many of them located in countries characterized by elevated political risk perceptions, is also consistent with PRI providers’ own climate finance targets. (vii) Regulatory risk remains a challenge, with adverse, unclear, and nontransparent regulations being a disincentive for FDI and foreign investor participation in public-private partnerships. One study reported that a one-point reduction in regulatory risk increases the likelihood of a new investment in a host country by 0.5–2 percentage points (World Bank 2020). Regulatory risk is especially pertinent for the green energy transition by negatively affecting renewable energy power generation and potentially giving rise to legal disputes between investors and states (World Bank Group and the Energy Charter Secretariat 2023). 62 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty (viii) Interconnections among different political risks can amplify negative impacts. Economic challenges can affect livelihoods and the availability and quality of services and social safety nets, which in turn may generate discontent that can culminate in political violence. Extreme weather events can lead to disruption of infrastructure and social services and food production, which can accentuate economic challenges and give rise to societal disruption. Concerns about climate change, loss of biodiversity, and pollution, among other issues, can give rise to protests and civil disturbances. In sum, intertwining environmental, geopolitical, and economic factors can elevate the likelihood of negative impacts from political risks. The 2024 MIGA-WAIPA global survey of investment promotion agencies (IPAs), based on their interactions with foreign investors (see chapter 2), highlighted adverse, unclear, or opaque regulatory policies as the top political risk by a significant margin (figure 3.1). This finding is consistent with previous evidence on political risk rankings.5 Regulatory risk may manifest itself in creeping or outright expropriatory events, transfer and convertibility restrictions, and breaches of contracts. War and civil disturbance events also featured prominently, reflecting increased societal and geopolitical tensions, political unrest arising from macroeconomic developments (debt challenges and sticky inflationary pressures), and election cycles. The category of “other” included regional tensions or conflicts, political rivalries, and changes in regulations pertaining to taxation, among other risks. Political risks may be interconnected, with inter-relationships accentuating a host country’s image. For example, conflicts, such as Russia’s invasion of Ukraine, can have negative economic impacts on other countries, potentially leading to restrictions on currency conversion and transfers, or to acts of expropriation. FIGURE 3.1 Ranking of political risks by importance to foreign investors, percent of respondents 0 10 20 30 40 50 60 70 Adverse or unclear Expropriation regulations are the SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK biggest political Terrorism risk Adverse, unclear, nontransparent regulations Non-honoring of government guarantees War (conflict with another country) Political unrest / civil disturbance (internal) Transfer and convertibility restrictions on FX █ All countries Breach of contract by public authorities █ Developing countries Other Source: MIGA-WAIPA survey. Note: Percentages add up to more than 100 percent because of multiple selections.  The MIGA-WAIPA Survey also asked IPAs to identify the factors posing the greatest constraints to FDI in 2024 (figure 3.2) and over the next three years (figure 3.3). Despite the prevalence of political risks, the responses closely focused on economic factors, often reflecting the operational needs of foreign investors. Developing country IPAs were even more concerned than respondents overall with practical operational issues. These included insufficient access to, or high cost of, financing, reflecting higher-for-longer interest rates; shortcomings of physical infrastructure; 5 See, for example, MIGA (2014). 63 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty insufficient access to qualified staff, in some cases accentuated by post-pandemic labor market tightness; high labor and input costs; inadequate or diminished supply chain linkages; and weak domestic and international environments. Regarding the latter, nearly 40 percent of all respondents expressed concerns about a weakening global economy. Somewhat surprisingly, the responses mostly did not indicate concerns about creditworthiness of state-owned enterprises (often the off- takers in public-private partnership structures) or foreign exchange availability—risks that could be mitigated by the political risk insurance industry. In part, this may reflect a focus on FDI in sectors that do not entail public-private partnerships or simply that these issues are not as prevalent in the host countries of IPA respondents. FIGURE 3.2 Constraints to FDI in 2024, percent of respondents 0 10 20 30 40 50 60 Operational issues Weak domestic economic environment pose the greatest Increased government intervention constraints to FDI Limited market-size opportunities at home Limited market opportunities abroad Limited physical infrastructure capacity (roads, rails, ports, etc.) Limited digital infrastructure (telecoms, high-speed internet, etc.) Insufficient access to qualified staff Perceived corruption Insufficient access to financing / high cost of financing Higher labor and input costs Climate change and climate transition risks Inadequate or diminished supply chain linkages War (conflict with another country or external non-state actor) Political unrest / civil disturbance (internal) Weak external economic environment Difficulties in acquiring foreign exchange █ All countries Creditworthiness concerns regarding domestic off-takers or clients SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK █ Developing countries Other (please specify) Source: MIGA-WAIPA survey. Note: Percentages add up to more than 100 percent because of multiple selections.  Access to qualified staff by foreign investors, linked to the post-pandemic tightness of labor markets, and a weaker global economic environment were also issues of great concern over the next three years (2025–27) for EMDEs (figure 3.3). Access to finance and the impact of higher-for- longer interest rates, as well as physical infrastructure deficiencies, were additional constraints. More than a third of respondents from all countries cited climate change as a constraint for the next three years compared with just under a quarter for the previous three years. Indeed, climate change showed the largest increase of any risk, in percentage points (10.2), between the current environment and the future for all countries, led by high-income economies. The increase was much lower for EMDEs. The potential impact of climate change on businesses can be significant, as discussed earlier, and this topic is clearly on the minds of IPAs and the foreign investors 64 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty they interact with. For companies and investors, climate change risks fall into three categories: physical risks, which can be imminent threats; transition risks from potentially higher business costs in response to new policies, laws, and regulations designed to address climate change; and liability risk arising from a failure to mitigate, adapt to, disclose, or comply with changing legal and regulatory expectations (Zurich 2024). FIGURE 3.3 Constraints to FDI over the next three years compared with the previous three years, percent of respondents 0 10 20 30 40 50 A weakening Weak domestic economic environment global economy will also be a major Increased government intervention FDI constraint Limited market-size opportunities at home Limited market opportunities abroad Limited physical infrastructure capacity (roads, rails, ports, etc.) Limited digital infrastructure (telecoms, high-speed internet, data centers) Insufficient access to qualified staff Perceived corruption Insufficient access to financing / high cost of financing Higher labor and input costs Climate change and climate transition risks Inadequate or diminished supply chain linkages War (conflict with another country or external non-state actor) Political unrest / civil disturbance (internal) Weak external economic environment Difficulties in acquiring foreign exchange █ All countries Creditworthiness concerns regarding domestic off-takers or clients █ Developing countries Other (please specify) Source: MIGA-WAIPA survey. Note: Percentages add up to more than 100 percent because of multiple selections.  PRI constitutes an option in the suite of instruments used by multinational enterprises to mitigate SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK political risk when investing abroad. While PRI is sometimes viewed as a negative cash flow element, a recent study by S&P Global suggests that PRI actually contributes additional value by enhancing investment returns and increasing asset valuations, especially in EMDEs (Marsh 2024). Other tools, such as engaging with host-country governments, undertaking political risk analysis, or using credit default swaps, are also common, as is forming joint ventures or alliances with local companies. The perspectives of select BU members based on the views of their clients suggests the prevalence of PRI as a commonly used mitigation tool. However, multinational enterprises may also choose not to engage in any form of mitigation owing to their respective risk tolerance. Going forward, considering heightened risks and based on indications from the first quarter of 2024, there is likely to be increased interest for both medium- and long-term commercial and PRI products (Berne Union 2024b). 65 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty Recent trends in political risk insurance After several years of expansion, PRI cover for investment by BU members (box 3.1) began to decline in 2017 and continued to fall through 2021 (figure 3.4). Between the peak of 2016 and the recent trough of 2021, new issuance for investment insurance declined cumulatively by 50 percent, mostly because of reduced coverage provided by export credit agencies (ECAs) that provide PRI. The decline started before the onset of the COVID-19 pandemic but was exacerbated by the pandemic in 2020 and 2021. (It should be noted, however, that the sharp decline in 2018 was primarily due to a change in reporting by a large ECA member6). Factors that contributed to the decline in 2020 included the paucity in international projects as borders closed or countries imposed restrictions, and the decline in FDI flows into developing countries in the face of sharp economic contractions or growth decelerations caused by the pandemic. FIGURE 3.4 FDI flows to EMDEs and PRI investment cover, 2005–23, $ millions PRI cover for 80,000 800,000 investment 70,000 700,000 began to decline in 2017 60,000 600,000 50,000 500,000 40,000 400,000 30,000 300,000 20,000 200,000 █ PRI cover, LHS 10,000 100,000 — FDI EMDEs, RHS 0 0 Linear (PRI cover) 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: Berne Union Secretariat; World Development Indicators database (World Bank).  Note: EMDEs = emerging markets and developing economies; PRI = political risk insurance. PRI cover includes issuance for developed countries; PRI providers may provide cover for a portfolio SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK of assets which can include assets in developed countries, or they may issue guarantees for projects in developed countries. PRI cover also reflects adjustments for multi-country policies to take into account overall policy limits in multi-country issuance.  PRI issuance for investment rebounded in 2022, with demand driven by renewed geopolitical concerns, Russia’s invasion of Ukraine, political violence in FDI host countries, macroeconomic challenges in the aftermath of the pandemic, the commodity shock, high levels of indebtedness in select developing economies, and difficulties in accessing foreign exchange. ECAs and private insurers contributed to the rebound, registering increases of 23 percent and 46 percent, respectively. Multilateral insurers recorded a 9 percent decline. While the rebound overall was strong—23 percent in 2022 over the previous year—significant catching up will still be needed to reach the PRI volumes issued before the pandemic, and during the heights reached in the mid- 2010s. In 2023, BU members issued $41 billion in investment insurance, down 4 percent over the previous year (figure 3.4). The small overall contraction in PRI is in sharp contrast to medium- and long-term 6 Overall trends in PRI data may have been influenced by underwriting changes by that ECA. 66 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty BOX 3.1 The structure of the political risk insurance industry Political risk insurance (PRI) encompasses mostly noncommer- In existence since 1934, the Berne Union (BU) is the interna- cial risks, such as direct and indirect actions by host govern- tional association for the export credit and investment insurance ments that adversely affect investments. The following are the industry; its mission is to actively facilitate cross-border trade political risks commonly insured by the PRI industry: (i) expro- by supporting international acceptance of sound principles priation – outright confiscations, expropriations, and national- in export credit and foreign investment. The BU comprises izations, as well as losses resulting from a series of acts that 84 members, including one observer. The BU defines PRI as cumulatively have an expropriatory effect; (ii) breach of contract insurance or a guarantee that indemnifies an equity investor or / arbitration award default – a host government’s breach or a bank financing the equity investment for losses incurred to a repudiation of a contractual agreement with an investor, with cross-border investment because of political risks. Essentially, claims typically payable after an investor has invoked a dispute PRI is a risk mitigation tool that protects investors when they set resolution mechanism (such as arbitration), obtained an award up businesses in developing countries and helps unlock financ- for damages, and the host government has failed to honor the ing. BU members providing PRI for cross-border investment award; (iii) currency inconvertibility and transfer restrictions – ina- comprise ECAs, private insurance companies, and multilat- bility to convert local currency into foreign exchange and transfer eral/regional agencies. The BU’s Prague Club, an information it out of the host country in a timely fashion; (iv) political violence exchange network for insurers of export credit and investment (war, terrorism, and civil disturbance) – damages to tangible as- mostly representing developing countries, was started in 1993 sets or business interruption caused by war, insurrection, rebel- with funding from the European Bank for Reconstruction and lion, revolution, civil war, vandalism, sabotage, civil disturbance, Development. Outside the BU, the PRI for investment space strikes, riots, and terrorism; and (v) non-honoring of sovereign includes private insurers or reinsurers, including those under the financial obligation – a government’s failure to make a payment Lloyd’s Syndicate, an insurance “marketplace” presently with when due under an unconditional financial payment obligation 59 members. New insurers help expand capacity. Recently, or guarantee given in favor of a project that meets an insurer’s Africa Specialty Risks launched a new syndicate at Lloyd’s requirements (this risk is also relevant for financial obligations by aimed at underwriting PRI (among other types of insurance) sub-sovereigns and state-owned enterprises). for projects in Africa (Atkins 2024). Reinsurance firms provide coverage related to PRI for investment activities. ECAs and The PRI industry comprises three broad categories of provid- multilateral organizations also offer reinsurance for PRI, albeit to ers—public, private, and multilateral insurers—and covers both a lesser extent. export or trade credit and investment insurance. For this report, PRI refers to investment insurance. As a specialized line of busi- Over time, PRI providers have expanded their offerings to ness, the PRI industry is affected by the demand for PRI itself respond to the evolving needs of foreign investors. Traditionally, SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK as well as by changes in capital availability and risk appetite in PRI cover protected investors against the risks of expropriation, the broader insurance market. Private reinsurance companies breach of contract, transfer and convertibility restrictions, and underwrite PRI-related coverage for trade and investment and war and civil disturbance. Offerings now include protection their presence contributes to increasing capacity in the private against the risk of governments (national or subnational) and market. Public insurers usually comprise national export credit state-owned enterprises not honoring their financial obligations, agencies (ECAs), which typically provide insurance only to with obligations of subnational governments and state-owned companies and investors from their own countries. ECAs and enterprises not necessarily required to be backed by a govern- multilateral insurers also participate as PRI reinsurers, albeit on ment guarantee. Terrorism risk insurance has also been added to a smaller scale than private reinsurers. the war and civil disturbance cover. 67 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty FIGURE 3.5 PRI and medium- and long-term export credit insurance, $ millions Export credit 150,000 insurance issuance rose 120,000 sharply in 2023 90,000 60,000 █ PRI 30,000 █ Medium & long-term export credit insurance 0 2019 2020 2021 2022 2023 Source: Berne Union Secretariat.  export credit insurance issuance,7 which indemnifies the counterparty to a debt obligation from an export credit agency for losses incurred by nonpayment by the debt obligor, and which registered a 43 percent increase in 2023 (figure 3.5). ECAs and private insurers saw, respectively, 4 percent and 29 percent declines in new cover. Multilateral insurers, however, experienced a dramatic increase of 89 percent in new cover over the previous year, to $5.7 billion. This was not enough to offset the declines by ECAs and private insurers, however, because of the multilaterals’ relatively small share of the BU investment insurance market. Going forward, the expected increase in investment in renewable energy projects is expected to support demand for PRI. For BU ECAs based in developing countries and Prague Club multilateral members based in developing countries, which essentially capture the universe of public and multilateral PRI providers in developing countries, a somewhat similar picture emerges. PRI cover bounced back strongly in 2022 and increased by 5 percent in 2023 (figure 3.6), in contrast to the decline shown in figure 3.4 for all Berne Union PRI providers. Issuance has yet to reach pre-pandemic levels. With more FDI flows originating from developing countries, it may not be unreasonable to expect that issuance from developing country PRI providers, which accounted for 35 percent of total BU member SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK issuance in 2023, will increase, as these investors may also find it advantageous to mitigate political risks. The declining trend in the ratio of PRI issuance to FDI flows into developing countries is noteworthy (figure 3.7), reflecting the combination of the decline in PRI issuance since 2016 alongside a 7 Medium- and long-term insurance provides protection against commercial and political risk when extending credit terms of 1–20 years or longer. Typically, this insurance manifests as buyer credit insurance and facilitates backing for projects in energy, infrastructure, and the exploitation of natural resources. Short-term trade credit insurance, by comparison, typically is for less than one year. FIGURE 3.6 PRI cover provided by Berne Union and Prague Club members based in developing countries, 2019–23, $ millions PRI cover bounced 25,000 back strongly in 20,000 2022 15,000 10,000 5,000 0 2019 2020 2021 2022 2023 Source: Berne Union Secretariat. 68 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty FIGURE 3.7 Ratio of PRI issuance to FDI flows into developing countries, 2005–23, percent  The ratio of PRI 14 issuance to FDI 12 flows into 10 developing 8 countries has been on a 6 declining trend 4 2 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: Berne Union Secretariat; World Development Indicators database (World Bank). longer-term declining trend (though with significant year-to-year fluctuations in absolute values) in the level of FDI flows into developing countries (see chapter 1). On average, new PRI issuance as a ratio of FDI flows into developing countries declined from 11.1 percent in 2005–10 to 7.1 percent in 2020–23 (figure 3.7). This is a rough indication that even less FDI is covered by PRI despite elevated political risks. Although that ratio has not been high in the past—the highest value was 13 percent in 2016—it has been exceptionally low in recent years. In part, this is because PRI is used for investments in high-risk countries, which are often smaller FDI recipients and do not account for the bulk of FDI flows into developing countries. It may also reflect sensitivities to premiums paid for PRI in an environment of rising operating costs and higher inflation. As shown in figure 3.8, the ratio of PRI issuance is significantly higher for low-income and lower middle-income economies than for upper middle-income countries. For low-income economies, PRI issuance has been on an upward trend in terms of value, with year-to-year fluctuations reflecting the perceptions of more significant political risks compared with the other income groups. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK BOX 3.2 Carbon credits and political risk insurance Carbon credits provide a mechanism for compa- include expropriatory events in relation to land rights; nies to balance their carbon emissions by funding war and civil disturbance events that can result in initiatives that remove carbon from the atmosphere damages for carbon projects and inability to issue in other locations. Although the current market for carbon credits; breach of contract risk in relation to voluntary credit is modest, with an estimated annual carbon investment agreements; or carbon invest- issuance of $2 billion globally (Carney 2024), this ment agreements covered by a bilateral investment practice of voluntary carbon compensation has treaty. In part, such risks are driven by the unproven the potential to evolve into a market worth many nature of the nascent carbon credit market, complex billions of dollars worldwide. These funds could be rules, and uncertainty regarding changes in national instrumental in aiding developing nations with the policies and regulations, such as the ability to transition to low-carbon economies. trade carbon credits across borders. Political risk insurance can play an important role in mitigating Carbon credit markets are vulnerable to political such risks. Political risk insurers could apply existing risks, such as license revocation that can be con- products or develop new ones to mitigate such risks sidered an expropriatory event. Other relevant risks in the carbon credit space. 69 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty FIGURE 3.8 Ratio of PRI issuance to FDI flows into low-income, lower-middle-income, and upper-middle-income countries, 2005–23, percent   The ratio of PRI 80 issuance to FDI 70 flows is 60 significantly higher 50 for lower-income economies 40 30 20 █ LICs 10 █ LMICs 0 █ UMICs 2005 2006 2007 2008 2009 2010 2011 2012 2014 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: Berne Union Secretariat; World Development Indicators database (World Bank).  Note: PRI issuance has been calculated through aggregation across countries in each income group without any adjustments for policy limits in multi-country issuance. Income groups are based on 2023 World Bank income classification. LICs = low-income countries; LMICs = lower-middle-income countries; UMICs = upper-middle-income countries.  An expansion in the suite of products offered under PRI, or their application, could contribute toward increasing the cover for FDI projects. For example, new PRI products under development, such as PRI in relation to carbon credits (box 3.2) and fair and equitable treatment in bilateral investment treaties (box 3.3), could contribute to the development of the carbon credit market and better align with the future needs of foreign investors. Fair and equitable treatment in bilateral investment treaties BOX 3.3 and political risk insurance To address client needs, the political risk insurance Regulatory changes (such as tariff disruptions or (PRI) market needs to evolve its product offerings. grid encroachment) could adversely impact inves- Traditional PRI can cover expropriation (outright or tors, but these would not constitute expropriation creeping confiscation of land/operations, and so or breach of contract. Investors in this space ask if SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK on) and breach of contract between an investor there are other ways that PRI providers can support and a host government. Both covers have some them—for example, through a new type of cover- limitations: in the case of expropriation cover, the age focused on fair and equitable treatment (FET) or actions taken by the government may not rise to investment stability (regulatory stabilization clauses). the level of expropriatory actions, even if they are Such coverage could be deployed if the investor’s unfavorable to the investor. In the case of breach home country has a bilateral investment treaty with of contract, the client needs a formal and legally the host government (a breach of contract under binding contract with the host government and an bilateral investment treaty cover, which exists but arbitral award, which may be issued only after a is not widely used), or if a new coverage could be lengthy dispute resolution process. developed that utilizes third-party panels to judge whether an official government action creates a In some sectors, such as mini-grid development negative impact on investors that can be remediat- or distributed energy, there may not be a formal ed through PRI. and legally binding contract with the sovereign. 70 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty Industry trends Multilateral insurers have increased their presence in the PRI market in recent years, albeit from a comparatively low base (figure 3.9). Historically, multilateral insurers have held a small share of the PRI market (around 5 percent during 2005–23 on a cumulative basis), with ECAs at the forefront with 73 percent over that period. ECAs play an important role in augmenting PRI capacity and supporting FDI by domestic companies from their own countries. Multilateral insurers steadily increased their share from 2005 to 2023, resulting in a 10 percent share during the 2021–23 period. In 2023 alone that share reached 14 percent. The ability of multilateral insurers to cover companies from multiple countries or offer their products to investors in host countries that may be outside the comfort level of other investment insurance providers, combined with their convening power to negotiate with governments to avert claims, are factors that underscore this trend. Multilateral PRI providers are well equipped to handle the uncertainties present in complex environments, often utilizing instruments such as first-loss coverage to mitigate these risks. The market share of private insurers tends to fluctuate considerably from year to year, in part due to the small number of private insurers offering PRI that are members of the BU. Private insurers outside the BU may also offer PRI, and so do some—but not all—members of the Lloyd’s Syndicate. FIGURE 3.9 Percent of PRI issuance by type of Berne Union member, 2005–23  120 100 80 60 40 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK █ Multilaterals 20 █ Private █ ECAs 0 Source: Berne Union Secretariat. 2005–2010 2011–2015 2016–2020 2021–2023 Note: ECA = export credit agency. Typically, ECAs and private insurers tend to play complementary roles in capacity availability, with ECAs and multilaterals stepping in when capacity declines for private insurers. Losses, for example, may decrease capacity for private insurers. At times, however, ECAs and private insurers may compete, leading to crowding. Both ECAs and multilaterals can potentially fill any gaps caused by reduced capacity for certain countries in the private market and can provide capacity for large projects. Especially for multilaterals, their convening power constitutes an important component of their value proposition in a world increasingly characterized by friend-shoring, and where private reinsurers are not able to play a comparatively active role. 71 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty FIGURE 3.10 Claims paid by Berne Union members, 2005–23, $ millions Claims rose sharply 450 in 2022,then fell back 400 to trend levels 350 the next year 300 250 200 150 100 50 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: Berne Union Secretariat. Claims and recoveries PRI claims are volatile from year to year, and they often reflect payments for a few large claims. Breach of contract claims rose in the aftermath of the onset of the COVID-19 pandemic, likely reflecting earlier challenges in investments supported by PRI providers. The impact of the pandemic may take some time to manifest in claims, given that the process of international arbitration can be lengthy. Claims paid in connection with investment insurance issued by BU members reached an all-time high in 2022 (figure 3.10), reflecting, among other things, heightened political violence risk. Claims paid in 2023 for investment insurance declined significantly, in contrast to a sharp increase in claims for medium- and long-term trade credit (Berne Union 2024a). A small number of developing countries account for the majority of claims paid. ECAs paid nearly all—95 percent—of the total investment insurance claims paid during 2020–23. BU members expect increases in claims paid for 2024 in light of ongoing conflicts and geopolitical tensions, as well as concerns around sovereign defaults and the high risks of debt distress in SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK developing countries. By type of political risk, claims in relation to political violence topped the list in 2023 (figure 3.11), reflecting, among others, geopolitical tensions and conflicts, such as Russia’s invasion of Ukraine; domestic events, such as coups and election-related violence and civil disturbance events; and FIGURE 3.11 Claims paid by Berne Union members by type of political risk, $ millions  Claims related to 300 political violence risk topped the list 250 in 2023 200 150 █ Unspecified 100 █ Political violence █ Breach of contract 50 █ Expropriation █ Transfer/convertibility 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: Berne Union Secretariat. 72 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty terrorism. Compared with previous years, claims related to transfer and convertibility restrictions rose sharply in 2023, indicative of the economic impacts of the COVID-19 pandemic and the commodity price shock that followed, strained national budgets, diminished access to capital markets for weakened developing countries, and the prevailing high-interest rate climate. Claims for expropriation declined in 2023. While the size of claims for expropriation and breach of contract risks is usually bigger than that for political violence events, the latter may manifest more frequently than the former, and typically there is no recovery associated with such events. Taking a longer- term perspective, the manifestation of climate change risks could exacerbate claims. PRI claim payments expressed as a ratio of maximum liability, a measure of overall PRI capacity, reached 0.23 percent in 2022,8 the highest since 2005. On average, that ratio has increased since the middle of the past decade, nearly doubling in 2021–23 compared with 2016–20 (figure 3.12), reflecting a global environment of heightened risk. Recoveries for PRI are reimbursements for losses, which allow insurers to increase capacity. PRI recoveries by insurers typically pertain to claims paid in previous years, and as such their pattern differs from that for claims. Recoveries suggest that PRI providers can successfully recoup a portion of the payments to guarantee holders through subrogation. High levels of recoveries suggest that the losses initially anticipated from claims were not as acute as might have been expected. FIGURE 3.12 Ratio of claims to maximum liability for Berne Union members, percent  This measure of 0.15 overall PRI capacity 0.12 has nearly doubled during the last 0.09 decade 0.06 0.03 0.00 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Source: Berne Union Secretariat. 2005–10 2011–15 2016–20 2021–23 8 MIGA calculations. 73 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty Conclusion The COVID-19 pandemic, followed by the commodity price shock, caused significant economic disruption and had severe implications for many countries’ sovereign balance sheets, accentuating sovereign risk. These economic struggles led to foreign exchange shortages in several countries, fueling transfer and convertibility restrictions and challenging the ability and willingness of governments and state-level authorities to honor contractual obligations vis-à-vis foreign investment. Post-pandemic macroeconomic uncertainty continues, as many developing economies are still struggling to recover from the pandemic and commodity price shock. Elevated debt levels, high risks of debt distress, sovereign defaults, and ongoing foreign exchange shortages are prevalent in select economies. Concerns about inflationary pressures have exacerbated social imbalances and existing inequalities, leading to increased public dissatisfaction, frequent social unrest, and abrupt political leadership changes. These recent developments underscore traditional political risks that are still quite prominent, such as foreign investor concerns about adverse, unclear, and nontransparent regulations in host countries as per the findings of the MIGA-WAIPA Survey. In an increasingly divided and contentious world, incidents of war and civil disturbance have become more prevalent and prominent. These events are not only more frequent but also more visible, reflecting the growing tensions and conflicts within and between nations. The rise in such disturbances underscores the fragile state of global stability and the risks that this entails for foreign investors. Taking a longer-term perspective, the palpable effects of climate change, with record high temperatures and extreme weather events, are likely to amplify macroeconomic challenges. Moreover, the long-term costs of the global energy transition (and for fossil fuel exporters, the loss of export revenues in the absence of adequate diversification), may further strain sovereign balance sheets and external positions. In turn, these developments can negatively impact a country’s ability or willingness to honor SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK contractual obligations or increase the risk of currency inconvertibility and transfer restrictions. The post-pandemic rebound in PRI issuance has been slow and has not returned to pre-pandemic levels despite elevated political risk perceptions. The decline in FDI flows to developing countries in 2023 was coupled with a small drop in PRI issuance following a rebound in the previous year. It is noteworthy that even pre-pandemic levels of PRI cover were marked by declines. Indeed, only a small portion of annual FDI flows to developing countries is typically covered by PRI, exemplified by the low—and declining—PRI issuance-to-FDI-flow ratio. While that ratio is higher when considering low- and lower-middle-income countries together, at just below one-third during 2020–23, the majority of FDI flows remain unmitigated against political risk. Additionally, concerns over political risks by investors, which underpin the demand for such insurance, may be predominantly focused on destinations that absorb only a small fraction of FDI flows, such as low-income countries. Taking these considerations into account, renewable energy and the green transition could support a rebound in PRI for investment in 2024 and beyond. The need to access critical minerals essential for the low-carbon transition, and the increase in renewable energy projects (including green hydrogen) and other climate-smart investments, bode well for both FDI flows and, potentially, PRI cover. However, with global economic and technological developments, national commitments for 74 © MIGA, 2024 Chapter 3 Political risk insurance in an age of uncertainty a green transition, new perils, and stated concerns about adverse regulatory changes, PRI insurers may need to explore new products or evolve existing ones to meet foreign investors’ changing needs. Examples in this regard include the application of PRI instruments to carbon credit markets and to the “fair and equitable treatment” standard under bilateral investment treaties. Combining PRI with other risk mitigation instruments can provide a more comprehensive cover for investment. Developing country investors, who are more likely to encounter challenges owing to their lack of overseas investment experience, also represent a market that can be further explored. To reduce claims and the potential for investment disputes, greater efforts could be made to help developing countries negotiate better contracts, despite expressed limitations of this approach (Sauvant, Tsang, and Wells 2023). Ultimately, improving the regulatory environment in host countries can contribute toward lessening political risk perceptions. Public sector PRI providers continue to play an important role in supporting FDI from their home countries and account for most PRI issuance among BU members. Multilateral PRI providers have doubled their share of PRI issuance, but from a small initial base. Multilateral providers are more likely to be issuing guarantees in riskier environments, at times aided by first-loss and blended guarantee instruments, helping to support FDI flows there. Developing country ECAs and multilateral providers continue to support outward FDI from developing countries; for the former, 2023 saw a small increase in issuance. PRI claims triggered by events under coverage reached a record level in 2022 but declined thereafter. Claims regarding transfer and convertibility risk, which used to be minuscule, rose in the aftermath of the pandemic, as did claims about political violence. PRI claims have crept up over the past decade, but PRI recoveries reimbursing for losses have also increased, replenishing the capacity of PRI providers to support FDI. In sum, at a time of heightened perceptions of new and traditional political risks, PRI offers an effective mitigation instrument. As the FDI landscape changes in response to near-shoring and friend-shoring, multilateral PRI providers may be particularly well positioned to address political risks in new locations because of their perceived neutrality and the ability to leverage their convening power to de-escalate disputes before they escalate into claims. To better meet the expectations and needs of foreign investors, continuous product innovation and product adaptability will be important. There is also a need for investors to further recognize the relevance of PRI instruments and better understand the offerings as the FDI landscape evolves. 75 © MIGA, 2024 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 76 References © MIGA, 2024 References References Ahn, J., A. Habib, D. Malacrino, and A. F. Presbitero. 2023. “Fragmenting Foreign Direct Investment Hits Emerging Economies Hardest.” IMF Blog, April 5, 2023. Aiyar, S., D. Malacrino, and A. Presbitero. 2023. “Investing in Friends: The Role of Geopolitical Alignment in FDI Flows.” NCAER Working Paper 158, National Council of Applied Economic Research, New Delhi. https://www.ncaer. org/wp-content/uploads/2024/02/WP158-FDI_Fragmentation_Aiyar_Malacrino_PresbiteroNCAER.pdf. Alfaro, L., and D. Chor. 2023. “Global Supply Chains: The Looming ‘Great Reallocation.’” NBER Working Paper 31661, National Bureau of Economic Research, Cambridge, MA. http://www.nber.org/papers/w31661. Arc Group. 2024. “China Plus One” – Who Is Your “Plus One”? Arc Group, January 26, 2024. Atkins, A. 2024. “New Lloyd’s Africa Syndicate Aims to Close Underwriting Capacity Gap.” Global Trade Review, May 1, 2024. https://www.gtreview.com/news/africa/new-lloyds-africa-syndicate-aims-to-close-underwriting-capacity- gap. Atkins, B. 2023. “Manufacturing Moving Out of China for Friendlier Shores.” Forbes, August 7, 2023. Ayenew, B. B. 2022. “The Effect of Foreign Direct Investment on the Economic Growth of Sub-Saharan African Countries: An Empirical Approach.” Cogent Economics & Finance 10 (1). Balistreri, E. J., and Z. Olekseyuk. 2021. “Economic Impacts of Investment Facilitation.” Working Paper Series 21-WP 615, Center for Agricultural and Rural Development, Iowa State University. Banco de Mexico. 2022. “Opinión empresarial sobre la relocalización de las empresas hacia México.” In Reporte sobre las Economías Regionales, September 2022. https://www.banxico.org.mx/publicaciones-y-prensa/reportes- sobre-las-economias-regionales/recuadros/%7BE243D1D1-63F5-6C86-38F0-28BD3CF33CE6%7D.pdf. Bangladesh Bank. 2024. Foreign Direct Investment and External Debt: July–December, 2023. Statistics Department. Dhaka. https://www.bb.org.bd/pub/halfyearly/fdisurvey/fdisurveyjuldec2023.pdf. Bellucci, C., and A. Rungi. 2023. “Navigating Uncertainty: Multinationals’ Investment Strategies after the Pandemic Shock.” Italian Economic Journal 9: 967–96. https://doi.org/10.1007/s40797-023-00244-4. Berger, A., A. Dadkhah, and Z. Olekseyuk. 2021. “Quantifying Investment Facilitation at Country Level: Introducing a New Index.” Discussion Paper 23/2021, Deutsches Institut für Entwicklungspolitik, Bonn. https://doi.org/10.23661/dp23.2021. Berger, K. P. 2021. “Renegotiation and Adaptation of International Investment Contracts.” Vanderbilt Journal of Transnational Law 36 (4): 1347. https://scholarship.law.vanderbilt.edu/vjtl/vol36/iss4/9. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Berne Union. 2024a. “BU Members Reflect on a Prodigious Year for New Business in 2023, despite an Increasingly Fractious Risk Environment.” Press release, April 24, 2024. Berne Union. 2024b. Business Confidence Index Q1.24. London: Berne Union. Bolhuis, M., H. Mighri, H. Rawlings, M. I. Reyes, and Q. Zhang. 2024. “How Vulnerable Is Sub-Saharan Africa to Geoeconomic Fragmentation?” IMF Working Paper 2024/083, International Monetary Fund, Washington, DC. https://ssrn.com/abstract=4790227. Braw, E. 2022. “Companies Are Fleeing China for Friendlier Shores.” Foreign Policy, August 2, 2022. Busse, M., and C. Hefeker. 2007. “Political Risk, Institutions and Foreign Direct Investment.” European Journal of Political Economy 23 (2): 397–415. Caldara, D., and M. Iacoviello. 2022. “Measuring Geopolitical Risk.” American Economic Review 112 (4): 1194–225. Capoot, A. 2024. “Apple Doubles India iPhone Production to $14 Billion as It Shifts from China.” CNBC, April 10, 2024. Carney, M. 2024. “Stop Debating Carbon Markets and Start Building Them.” Financial Times, June 17, 2024. Chase-Dunn, C., A. Álvarez, and Y. Liao. 2023. “Waves of Structural Deglobalization: A World-Systems Perspective.” Social Sciences 12 (5): 301. Chu, A., C. Kay. 2024. “Indian companies move in as US cuts China out of its solar industry.” Financial Times, October 6, 2024. 77 © MIGA, 2024 References Citibanamex. 2022. “Propiedades industriales de México.” Las Últimas de Fundamental. December 23, 2022. https:// www.banamex.com/sitios/analisis-financiero/notas/mercado-de-capitales/2481747.html. Cotula, L. 2019. “Reconsidering Sovereignty, Ownership and Consent in Natural Resource Contracts: From Concepts to Practice.” In European Yearbook of International Economic Law 2018, edited by M. Bungenberg, M. Krajewski, C. J. Tams, J. P. Terhechte, and A. R. Ziegler. Springer, Cham. https://doi.org/10.1007/8165_2018_23. Debroy, B., and A. Sinha. 2024. “India’s Economic Realignment.” In Rising to the China Challenge: Sino-Indian Ties Under Modi, edited by H. V. Pant and K. A. Mankikar. New Delhi: ORF and Global Policy Journal. Della Posta, P. 2022. “Global Value Chains and the Slowing Down of Globalisation.” Perspectivas – Journal of Political Science, 27: article 5. https://doi.org/10.21814/perspectivas.4564. Dobson, O., and P. Roberts. 2024. “Rising Political Risks Overshadow ‘Friendshoring’ Shift.” Verisk Maplecroft, January 18, 2024. https://www.maplecroft.com/products-and-solutions/sustainable-supply-chain/insights/rising- political-risks-overshadow-friendshoring-shift/ Dunning, J. H. 2001. “The Eclectic (OLI) Paradigm of International Production: Past, Present and Future.” International Journal of the Economics of Business 8 (2): 173–90. Echandi, R., I. A. Nimac, and D. Chun. 2019. Retention and Expansion of Foreign Direct Investment, vol. 2, Political Risk and Policy Responses. Washington, DC: World Bank Group. Express Defence. 2024. “Comprehensive Economic Partnership in Focus as India and Bangladesh Ink New Pacts.” Financial Express, June 22, 2024. Freund, C., A. Mattoo, A. Mulabdic, and M. Ruta. 2023. “Is U.S. Trade Policy Reshaping Global Supply Chains?” Policy Research Working Paper 10593, World Bank, Washington, DC. https://openknowledge.worldbank.org/entities/publication/4edfe909-2761-4b03-b8a7-153650da7cf6. Gereffi, G. 2023. “How to Make Global Supply Chains More Resilient.” Columbia FDI Perspectives 348, Columbia University, New York, NY. GI Hub (Global Infrastructure Hub). 2017. “Global Infrastructure Investment Need to Reach USD97 Trillion by 2040.” Global Infrastructure Hub, July 25, 2017, https://www.gihub.org/media/global-infrastructure-investment-need-to-reach-usd97-trillion-by-2040/. Góes, C., and E. Bekkers. 2022. “The Impact of Geopolitical Conflicts on Trade, Growth, and Innovation.” Staff Working Paper ERSD-2022-09, World Trade Organization, Geneva. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK https://www.wto.org/english/res_e/reser_e/ersd202209_e.htm. Goksu, E. B., T. Bikoi, and P. H. Gobin. 2022. “Special Purpose Entities Shed Light on the Drivers of Foreign Direct Investment.” IMF Blog, March 25, 2022. https://www.imf.org/en/Blogs/Articles/2022/03/25/special-purpose- entities-shed-light-on-the-drivers-of-foreign-direct-investment. Gopinath, G. 2024. “Geopolitics and Its Impact on Global Trade and the Dollar.” Speech in the series on the Future of the International Monetary System (IMS), Stanford Institute for Economic Policy Research, May 7, 2024. https://www.imf.org/en/News/Articles/2024/05/07/sp-geopolitics-impact-global-trade-and-dollar-gita-gopinath. Grieveson, R., Z. Nechev, and R. Parkes. 2023. “How Germany Can Realize Friendshoring in Its Neighborhood: A Half Step Plan.” DGAP Policy Brief 25, Forschungsinstitut der Deutschen Gesellschaft für Auswärtige Politik e.V., Berlin. https://nbn-resolving.org/urn:nbn:de:0168-ssoar-89981-2. Hasna, Z., F. Jaumotte, J. Kim, S. Pienknagura, and G. Schwerhoff. 2023. “Green Innovation and Diffusion: Policies to Accelerate Them and Expected Impact on Macroeconomic and Firm-Level Performance.” IMF Staff Discussion Note 2023/08, International Monetary Fund, Washington, D.C. IMF (International Monetary Fund). 2023a. Greenfield Investment and Extension of Capacity. Washington, DC: IMF. IMF. 2023b. “Staff Report.” In Vietnam. IMF Country Report 23/338. Washington, DC: IMF. https://www.imf.org/-/media/Files/Publications/CR/2023/English/1VNMEA2023003.ashx. IMF. 2023c. World Economic Outlook: A Rocky Recovery. April. Washington, DC: IMF. 78 © MIGA, 2024 References Izadi, J., and B. Madirimov. 2023. “Effect of Foreign Direct Investment on Sustainable Development Goals? Evidence from Eurasian Countries.” Journal of Sustainable Finance & Investment, January, 1–20. Javorcik, B. 2020. “Global Supply Chains Will Not Be the Same in the Post-COVID-19 World.” In COVID-19 and Trade Policy: Why Turning Inward Won’t Work, edited by R. E. Baldwin and S. J. Evenett. London: Centre for Economic Policy Research. Javorcik, B., L. Kitzmüller, H. Schweiger, and M. A. Yildirim. 2023. “Economic Costs of Friend-Shoring.” CESifo Working Paper 10869, CESifo Network, Munich. https://ssrn.com/abstract=4696010. Jaumotte, F., J. Kim, S. Pienknagura, and G. Schwerhoff. 2024. “Policies to Foster Green FDI: Best Practices for Emerging Market and Developing Economies” IMF Staff Climate Note 2024/004, International Monetary Fund, Washington, DC. Knox, B. 2023. “Navigating Electrical Supply Chain Issues as a Small Contractor.” Raiven, March 3, 2023. https://www.raiven.com/blog/navigating-electrical-supply-chain-issues-as-a-small-contractor. Kouam, A. W. F. 2024. “Navigating the Relocation Trend: The Rising Shift of Multinational Corporations from China to Other Countries.” International Journal of Science and Business 34 (1). Kox, H. L., and H. Rojas-Romagosa. 2020. “How Trade and Investment Agreements Affect Bilateral Foreign Direct Investment: Results from a Structural Gravity Model.” World Economy 43 (12): 3203–42. Kusek, P. 2020. Global Investment Competitiveness Report 2019-2020: Rebuilding Investor Confidence in Times of Uncertainty. Washington, DC: World Bank. http://documents.worldbank.org/curated/en/403901590645496246/ Global-Investment-Competitiveness-Report-2019-2020-Rebuilding-Investor-Confidence-in-Times-of- Uncertainty. Marsh. 2024. “Unlocking the Power of Political Risk Insurance.” Marsh, March 12, 2024. https://www.marsh.com/ en/services/political-risk/insights/cost-and-benefits-of-political-risk-insurance-for-foreign-direct-investments. html#:~:text=S%26P%20Global’s%20independent%20study%2C%20commissioned,project’s%20internal%20 rate%20of%20return. McLaughlin, E., and D. M. Peterson. 2023. “A Reshoring Renaissance Is Underway.” MIT Sloan Management Review, November 2, 2023. https://sloanreview.mit.edu/article/a-reshoring-renaissance-is-underway/. Mejia, S. A. 2023. “The Economic Growth Effects of Foreign Direct Investment in Developing Countries, 1980–2019.” International Journal of Sociology 53 (4): 239–60. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK MIGA (Multilateral Investment Guarantee Agency). 2012. World Investment and Political Risk 2011. Washington, DC: World Bank Group. MIGA. 2014. World Investment and Political Risk 2013. Washington, DC: World Bank Group. https://www.miga.org/sites/default/files/archive/Documents/WIPR13.pdf. Mitchell, C. 2023. “Governance Upgrade Puts Gambia on the FDI Map.” FDI Intelligence, April 24, 2023. https://www.fdiintelligence.com/content/feature/governance-upgrade-puts-gambia-on-the-fdi-map-82278. National News Agency of Bangladesh. 2024. “Bangladesh, China Exchange Feasibility Study Report to Sign FTA Agreement.” BSS News, March 28, 2024. Nayyar, G., M. Hallward-Driemeier, and E. Davies. 2021. At Your Service? The Promise of Services-Led Development. Washington, DC: World Bank. OECD (Organisation for Economic Co-operation and Development). 2024. FDI in Figures: April 2024. Paris: OECD. Office of Sherrod Brown. 2024. “Brown Calls on Biden Administration to Stop China from Breaking into USMCA Trade Agreement.” News release, September 19, 2024. https://www.brown.senate.gov/newsroom/press/release/ brown-calls-on-biden-administration-to-stop-china-from-breaking-into-usmca-trade-agreement. Office of the Prime Minister of Thailand. 2024. “Thailand and Bangladesh Strengthen Ties with New Agreements.” News release, Public Relations Department, April 29, 2024. 79 © MIGA, 2024 References Oxford Analytica. 2023. “‘Near-shoring’ May Bring FDI to Eastern Europe.” Expert Briefings. https://doi.org/10.1108/OXAN-DB282930. Partridge, C. 2024. “Geopolitics and Geology: Enhancing Mining Companies’ Resilience amid Political Risk Uncertainty.” Marsh, May 6, 2024. https://www.marsh.com/en/industries/mining/insights/enhancing-mining-companies- resilience-amid-political-risk-uncertainty.html. Ratha, D., Eung Ju Kim, A. Mahmood, S. Plaza, W. Shaw, and Xiao’ou Zhu. 2023. Market Finance for Development: Taking stock. Washington, DC: MIGA, World Bank. https://www.miga.org/sites/default/files/2023-12/ MarketFinance_MIGA.pdf. Saurav, A., and B. B. Viney. 2020. Catalyzing Investment for Green Growth: The Role of Business Environment and Investment Climate Policy in Environmentally Sustainable Private Sector Development. Washington, DC: World Bank. https://documents.worldbank.org/en/publication/documents-reports/ documentdetail/464811610960949219/catalyzing-investment-for-green-growth-the-role-of-business- environment-and-investment-climate-policy-in-environmentally-sustainable-private-sector-development. Sauvant, K. P., V. S. W. Tsang, and L. T. Wells. 2023. “The Limits of Capacity Building for Investment Contract Negotiations.” Columbia FDI Perspectives 359, Columbia University, New York, NY. https://ssrn.com/abstract=4474456. Seong, J., O. White, M. Birshan, L. Woetzel, C. Lamanna, J. Condon, and T. Devesa. 2024. Geopolitics and the Geometry of Global Trade. McKinsey Global Institute. https://www.mckinsey.com/mgi/our-research/geopolitics- and-the-geometry-of-global-trade?stcr=DA3559BD665749AB87CC1B57384B457F&cid=other-eml-nsl-mip- mck&hlkid=1d035f495e02472db005afc1c106117a&hctky=2196966&hdpid=29b31c7e-2f94-431c-b379- ae4f3291fe8b#/. Shin, Y. H. 2024. “Korean Multinational Corporations’ Global Expansion Strategies in Manufacturing Sector: Mother Factory Approach.” International Journal of Internet, Broadcasting and Communication 16 (1): 269–79. Star Business Report. “FTA with China May Cost Bangladesh Tk 15,000cr a Year: Study.” Daily Star, March 29, 2024. Tafese, T., J. Lay, and V. Tran. 2023. “From Fields to Factories: Special Economic Zones, Foreign Direct Investment, and Labour Markets in Vietnam.” GIGA Working Papers 338, German Institute of Global and Area Studies, Hamburg. Takahashi, T., and Y. Nitta. 2023. “Bangladesh Holding Free Trade Talks with 11 Countries: PM Hasina.” Nikkei Asia, April 20, 2023. https://asia.nikkei.com/Editor-s-Picks/Interview/Bangladesh-holding-free-trade-talks-with-11- SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK countries-PM-Hasina. Telling, O., W. Langley, A. Lin, and H. Chan. 2024. “Chinese Businesses Target Vietnam and Mexico as Trade Tensions with US Rise.” Financial Times, June 2, 2024. Tiftik, E., K. Mahmood, and R. Aycock. 2024. “Navigating the New Normal.” IIF Global Debt Monitor, May 7, 2024. TSMC Arizona. 2024. “TSMC Arizona and U.S. Department of Commerce Announce up to US$6.6 Billion in Proposed CHIPS Act Direct Funding, the Company Plans Third Leading-Edge Fab in Phoenix.” News release, April 9, 2024. https://pr.tsmc.com/english/news/3122. UNCTAD (United Nations Trade and Development). 1991. World Investment Report 1991. Geneva: UNCTAD. UNCTAD. 2024a. “The Gambia: Unleashing Investment Potential for Sustainable Development.” UNCTAD News, July 30, 2024. https://unctad.org/news/gambia-unleashing-investment-potential-sustainable- development#:~:text=From%202017%20to%202021%2C%20foreign,time%20high%20of%20%24249%20 million. UNCTAD. 2024b. Global Economic Fracturing and Shifting Investment Patterns. Geneva: UNCTAD. https://unctad.org/ system/files/official-document/diae2024d1_en.pdf. UNCTAD. 2024c. Global Trade Update: March 2024. Geneva: UNCTAD. UNCTAD. 2024d. World Investment Report 2024. Geneva: UNCTAD. Verisk Maplecroft. 2024. “Risk Signals: Trends to Watch in 2024” (by Jess Middleton). Verisk Maplecroft Insight. January. 80 © MIGA, 2024 References WEF (World Economic Forum). 2023. “2024 Is a Record Year for Elections. Here’s What You Need to Know.” Geo- economics and Politics, World Economic Forum, December 15, 2023, https://www.weforum.org/agenda/2023/12/2024-elections-around-world. WEF. 2024. Global Risks Report 2024. Geneva: WEF. https://www.weforum.org/publications/global-risks-report-2024. The White House. 2022. “CHIPS and Science Act Will Lower Costs, Create Jobs, Strengthen Supply Chains, and Counter China.” Fact sheet handed out in the Briefing Room, August 9, 2022. https://www.whitehouse.gov/ briefing-room/statements-releases/2022/08/09/fact-sheet-chips-and-science-act-will-lower-costs-create-jobs- strengthen-supply-chains-and-counter-china. Wildsmith, J. 2024. “China Shifts to Capital Exports.” fDi Intelligence. https://www.fdiintelligence.com/content/feature/ china-shifts-to-capital-exports-83834. World Bank. 2020. Global Investment Competitiveness Report 2019/2020: Rebuilding Investor Confidence in Times of Uncertainty. Washington, DC: World Bank Group. World Bank. 2021. Creating Markets in Vietnam. Washington, DC: World Bank Group. World Bank. 2022. Investment Policy and Promotion Operational Guide. Washington, DC: World Bank Group. https://documents.worldbank.org/en/publication/documents-reports/documentdetail/099040009302225750/ p1755370c5dafe0440b2e40efcc6443b101. World Bank. 2023. Changing Foreign Direct Investment Dynamics and Policy Responses: White Paper for Japan’s G7 Presidency. Washington, DC: World Bank Group. World Bank. 2024a. A Global Database of Inflation. Washington, DC: World Bank Group. World Bank. 2024b. Global Economic Prospects: June 2024. Washington, DC: World Bank Group. World Bank. 2024c. “Health and Climate Change.” April 5, 2024. https://www.worldbank.org/en/topic/health/brief/ health-and-climate-change#:~:text=A%20recent%20World%20Bank%20study,these%20driven%20by%20 health%20impacts. World Bank Group and the Energy Charter Secretariat. 2023. Enabling Foreign Direct Investment in the Renewable Energy Sector: Reducing Regulatory Risks and Preventing Investor-State Conflicts. Washington, DC: World Bank Group. Zurich. 2024. “Here’s How Climate Change Will Impact Businesses Everywhere—and What Can Be Done.” Zurich, May 3, 2024. https://www.zurich.com/en/knowledge/topics/climate-change/how-climate-change-will-impact- business-everywhere. 81 © MIGA, 2024 Appendix 1 IPA CEO Survey of Trends and Emerging Patterns in Foreign Direct Investment (FDI) SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 82 © MIGA, 2024 Appendix 1 This survey questionnaire was sent to members of the World Association of Investment Promotion Agencies (WAIPA) and was conducted in collaboration with the WAIPA Secretariat. SECTION A. Q4. In your opinion, which of the following factors will pose the greatest constraint to FDI in your country this year (2024) and over the next three years? (2025-2027) Q1. Information about the person completing the Select up to 5 responses in each column questionnaire: This year (2024) ┃ Next three years (2025-2027) Name ┃ Role Weak domestic economic environment CEO/President/Managing director Increased government intervention Investment Promotion Head/Manager Limited market-size opportunities at home Other C level executive Limited market opportunities abroad Other, please specify: Limited physical infrastructure capacity (roads, rails, Direct Telephone number ports, etc.) E-mail address Limited digital infrastructure (telecoms, high speed internet, data centers) Insufficient access to qualified staff Perceived corruption Q2. Basic facts about the IPA: Insufficient access to financing/high cost of financing Country Higher labor and input costs Name of your organization Climate change and climate transition risks Year your IPA was established Inadequate or diminished supply-chain linkages War (conflict with another country or external non-state actor) Political unrest/civil disturbance (internal) Q3. Do you represent a national-level IPA or a Weak external economic environment regional/state/provincial/city IPA? Difficulties in acquiring foreign exchange Geographical jurisdiction ┃Select one SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Creditworthiness concerns regarding domestic off- National takers or clients Regional (please list jurisdiction and name of IPA) Other (please specify) State/provincial (please list jurisdiction and name of IPA) City (please list jurisdiction and name of IPA) Q5. Do you expect the level of FDI into your country/geographical jurisdiction to change this year compared with last year, and over the next three years compared with the previous three years? Select one in each column This year/last year (2024/2023) Next three years /previous three years (2025-2027/2022-2024) Increase Decrease Unchanged 83 © MIGA, 2024 Appendix 1 Q6. How do you expect FDI into your country/ Q8. Which five countries have been the most geographical jurisdiction, by sector, to change prominent in your country/geographical this year compared with last year, and over the jurisdiction, based on FDI flows, during the last next three years compared with the previous three three years? years? List countries 1. ┃ 2. ┃ 3. ┃ 4. ┃ 5. This year (2024 v. 2023) Select one response per sector Increase ┃ Decrease ┃ Unchanged Agriculture, forestry and mining Q9. Based on your projections, which five countries Oil and natural gas will be the most prominent for your country/ Manufacturing geographical jurisdiction, based on FDI flows, over the next three years (2024-2026)? Utilities List countries 1. ┃ 2. ┃ 3. ┃ 4. ┃ 5. Transport/logistics Communications/digital Financial services Other services Q10. Thinking about your IPA’s interactions with actual or potential foreign investors over the last Next three years (2025-2027 v. 2022-2024) two years (2022-2023), which types of political risk Select one response per sector. in your country/geographical jurisdiction are of Increase ┃ Decrease ┃ Unchanged most concern to them? Agriculture, forestry and mining Type of political risk ┃ Select up to 3 Oil and natural gas Expropriation Manufacturing Terrorism Utilities Adverse, unclear or nontransparent regulatory policies Transport Non-honoring of government guarantees Communications/digital War Financial services (conflict with another country or external non-state actor) Other services Political unrest/civil disturbance (internal) Transfer and convertibility restrictions on foreign exchange Breach of contract by public authorities or state-owned enterprises Q7. How do you expect FDI into your country/ Other (please specify) geographical jurisdiction, by country of origin, to SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK change this year compared with last year, and over the next three years compared with the previous three years? This year/last year (2024/2023) Select only one option Next three years/previous three years (2025-2027/2022-2024) Select only one option Shift from developed country investors to emerging market investors Shift from emerging market investors to developed country investors No change 84 © MIGA, 2024 Appendix 1 SECTION B Q11. Thinking about your IPA’s encounters with actual or potential foreign investors over the last two years (2022-2023), rank the following geopolitical and global economic risks in terms of A half century of global economic integration is giving greatest concerns expressed by those investors way to a fragmented investment landscape increasingly vis-à-vis your country. defined by near-shoring, friend-shoring, and reshoring. Please rank from 1 (greatest concern) to 10 (least concern) This part of the survey asks for your views on these trends. We define these developments as follows: COVID pandemic War in Ukraine 1- “Friend-shoring” refers to a country’s decision to limit supply chain networks and the sourcing of US-China political and trade tensions inputs to countries allied with the home country War and armed conflicts in the Middle East and trusted partners that share similar values. High interest rates/cost of capital This implies that foreign investors will look to shift overseas production, or at least part of their Supply chain disruptions overseas supply chains, to such countries. Cost-of-living crisis/inflation 2- “Near-shoring” refers to a country’s transfer of (part Concerns around sovereign default/debt distress of the) global supply chain geographically closer to Financial market turmoil home. This implies that foreign investors will look Concerns around political/civil unrest to shift overseas production, or at least part of their overseas supply chains, to such countries. Other (please specify) 3- “Reshoring” refers to a country’s transfer of (part of the) global supply chain back home. This implies that foreign investors will look to shift overseas production, or at least part of their overseas supply Q12. Thinking about your IPA’s interactions with chains, back home. actual or potential foreign investors, rank the following geopolitical and global economic risks in terms of greatest likely concerns from those investors over the next three years (2024-2026). Please rank from 1 (greatest concern) to 10 (least concern) Q14. Thinking about your IPA’s interactions with Pronounced/persistent slowdown in China’s economy actual or potential foreign investors, how important do you expect the following investment trends Escalation of the war in Ukraine/regional spillover to be over the next three years (2024-2026) with US-China geopolitical and trade tensions worsen respect to your country/geographical jurisdiction? Global geopolitical fragmentation Trend War and armed conflicts in the Middle East expand Not important (1) ┃ Somewhat Important (2) ┃ Moderately Important (3) ┃ Very Important (4) Interest rates/cost of capital remain high Friend-shoring Supply chain disruptions resume SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Near-shoring High inflation persists or returns Reshoring Sovereign default/debt distress in countries of operation/investment New armed conflicts with global implications Political/civil unrest in important destination countries Q15. Thinking about your IPA’s interactions with Other (please specify) actual or potential foreign investors, to what extent do you expect your country/geographical jurisdiction to be affected by friend-shoring, on balance, over the next three years? Q13. How many foreign investors, existing or Extent of change from friend-shoring* Select one potential, have staff members of your IPA met Strongly positively affected with in each of the last five years (approximately). (e.g., significant increase in FDI inflows) Include all types of meetings—virtual as well as Positively affected in-person. (e.g., modest increase in FDI inflows) Number of foreign investor interactions No change in investment due to friend-shoring 2019 ┃ 2020 ┃ 2021 ┃ 2022 ┃ 2023 Negatively affected Less than 200 (e.g., modest divestment/decrease in FDI inflows) 200-499 Strongly negatively affected (e.g., significant divestment/decrease in FDI inflows) 500-1,000 *Assess “significant and modest” relative to the current presence of FDI More than 1,000 in your country. 85 © MIGA, 2024 Appendix 1 Q16. Thinking about your IPA’s interactions with Q18. If you believe your country/geographical actual or potential foreign investors, in which jurisdiction is likely to be positively affected by sectors do you expect your country/geographical friend-shoring, select the key reasons impacting jurisdiction to be most affected by friend-shoring, that investment decision: on balance, over the next three years? Select up to 5 Select all sectors that apply Strategic/political compatibility with FDI source Strongly positively affected ┃ Positively affected ┃ No change Negatively affected ┃ Strongly negatively affected countries Cultural compatibility with FDI source countries Utilities Supply chain integration with multinational companies Transport from FDI source countries Communications Safety/security of operations Agriculture, forestry and mining Compatible climate and sustainability policies/ Oil and natural gas standards Services Time zone advantages with FDI source countries Financial services Compatible environmental, social and governance Manufacturing (of which) (ESG) standards -Motor vehicles, trailers, etc. The effects of source-country environmental policies -Electrical equipment (e.g., the EU’s Carbon-Adjustment Border Mechanism, the US Inflation Reduction Act, etc.) -Computer, electronic, etc. The effects of friend-shoring have not been observed in -Food and beverages my country/jurisdiction -Wearing apparel and textiles -Machinery & equipment -Coke & refined petroleum prods. -Chemicals -Fabricated metals Q19. If you believe your country/geographical jurisdiction is likely to be negatively affected by -Basic metals friend-shoring, select the key reasons impacting -Rubber that investment decision: -Other non-metallic mineral prods. Select up to 5 -Pharmaceuticals Lack of strategic/political compatibility with FDI source -Wood countries Lack of cultural compatibility with FDI source countries Inadequate supply chain integration with multinational companies from FDI source countries SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Lack of safety/security of operations Q17. Thinking about your IPA’s interactions with actual or potential foreign investors, list the source Incompatible climate and sustainability policies/ countries (up to five) from which you are seeing standards changes in FDI flows related to friend-shoring, Time zone disadvantages with FDI source countries whether positive or negative. Incompatible environmental, social and governance Countries (up to five) for which the impact is positive (new (ESG) standards investment inflows) 1. ┃ 2. ┃ 3. ┃ 4. ┃ 5. The effects of source-country environmental policies (e.g., the EU’s Carbon-Adjustment Border Mechanism, the US Countries (up to five) for which the impact is negative (reduced Inflation Reduction Act, etc.) investment inflows) 1. ┃ 2. ┃ 3. ┃ 4. ┃ 5. The effects of friend-shoring have not been observed in my country/jurisdiction No change Tick here 86 © MIGA, 2024 Appendix 1 Q20. Thinking about your IPA’s encounters with Q22. Thinking about your IPA’s interactions with actual or potential foreign investors, to what extent actual or potential foreign investors, list the source do you expect your country to be affected by near- countries (up to five) from which you are seeing shoring, on balance, over the next three years? changes in FDI flows related to near-shoring, whether positive or negative. Extent of change from near-shoring.* Select one Countries (up to five) for which the impact is positive (new Strongly positively affected investment inflows) (e.g., significant increase in FDI inflows) 1. ┃ 2. ┃ 3. ┃ 4. ┃ 5. Positively affected (e.g., modest increase in FDI inflows) Countries (up to five) for which the impact is negative (reduced investment inflows) No change in investment due to near-shoring 1. ┃ 2. ┃ 3. ┃ 4. ┃ 5. Negatively affected (e.g., modest divestment/decrease in FDI inflows) No change Tick here Strongly negatively affected (e.g., significant divestment/decrease in FDI inflows) *Assess “significant and modest” relative to the current presence of FDI in your country. Q23. If you believe your country/geographical jurisdiction is likely to be positively affected by near-shoring, select the key reasons impacting that investment decision: Q21. Thinking about your IPA’s encounters with Select up to 5 actual or potential foreign investors, in which Distance /connectivity in terms of transport sectors do you expect your country to be most affected by near-shoring? Free/preferential trade agreements Time zone advantages Select all sectors that apply Strongly positively affected ┃ Positively affected ┃ No change Supply chain integration with multinational companies Negatively affected ┃ Strongly negatively affected from FDI source countries Utilities Compatible climate and sustainability policies/ Transport standards Communications Compatible environmental, social and governance (ESG) standards Agriculture, forestry and mining Government incentives Oil and natural gas The effects of source-country environmental policies Services (e.g., the EU’s Carbon-Adjustment Border Mechanism, the US Inflation Reduction Act, etc.) Financial services The effects of near-shoring have not been observed in Manufacturing (of which) my country/jurisdiction -Motor vehicles, trailers, etc. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK -Electrical equipment -Computer, electronic, etc. -Food and beverages -Wearing apparel and textiles -Machinery & equipment -Coke & refined petroleum prods. -Chemicals -Fabricated metals -Basic metals -Rubber -Other non-metallic mineral prods. -Pharmaceuticals -Wood 87 © MIGA, 2024 Appendix 1 Q24. If you believe your country/geographical Q26. Thinking about your IPA’s encounters with jurisdiction is likely to be negatively affected by actual or potential foreign investors, in which near-shoring, select the reasons: sectors do you expect your country/geographical jurisdiction to be most affected by reshoring? Select up to 5 Select all sectors that apply Longer distances/less connectivity in terms of transport Strongly positively affected ┃ Positively affected ┃ No change No free/preferential trade agreements Negatively affected ┃ Strongly negatively affected Time zone disadvantages Utilities Inadequate supply chain integration with multinational Transport companies from FDI source countries Communications Incompatible climate and sustainability policies/ standards Agriculture, forestry and mining Incompatible environmental, social and governance Oil and natural gas (ESG) standards Services The effects of source-country environmental policies Financial services (e.g., the EU’s Carbon-Adjustment Border Mechanism, the US Inflation Reduction Act, etc.) Manufacturing (of which) The effects of near-shoring have not been observed in -Motor vehicles, trailers, etc. my country/jurisdiction -Electrical equipment -Computer, electronic, etc. -Food and beverages -Wearing apparel and textiles Q25. Thinking about your IPA’s encounters with actual or potential foreign investors, to what -Machinery & equipment extent do you expect your country/geographical -Coke & refined petroleum prods. jurisdiction to be affected by reshoring, on balance, -Chemicals over the next three years? -Fabricated metals Extent of change from reshoring.* Select one -Basic metals Strongly positively affected -Rubber (e.g., significant increase in FDI inflows) -Other non-metallic mineral prods. Positively affected (e.g., modest increase in FDI inflows) -Pharmaceuticals No change in investment due to reshoring -Wood Negatively affected (e.g., modest divestment/decrease in FDI inflows) Strongly negatively affected (e.g., significant divestment/decrease in FDI inflows) SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK *Assess “significant and modest” relative to the current presence of FDI Q27. Thinking about your IPA’s interactions with in your country. actual or potential foreign investors, list the source countries (up to five) from which you are seeing changes in FDI flows related to reshoring, that is, repatriation of investment to home countries. Countries (up to five) for which repatriation to home countries is occurring (reduced investment inflows to your country) 1. ┃ 2. ┃ 3. ┃ 4. ┃ 5. No change from reshoring Tick here 88 © MIGA, 2024 Appendix 1 Q28. Thinking about your IPA’s encounters with Q29. Thinking about your government’s recent actual or potential foreign investors, what are the policies, do you expect a shift from imports to key factors driving reshoring? domestic production in critical/priority sectors over the next three years? Select up to 5 Select one Policies in FDI source countries encouraging reshoring Concerns about geo-political and trade tensions Yes National security considerations that support reshoring No in strategic/critical sectors Don’t know Supply chain bottlenecks and other disruptions Rising production costs in FDI host countries If yes, to what extent do you expect that such a shift to domestic production in critical/priority sectors will Rising transportation costs be open to foreign investment? Better access to specialized skills in FDI source countries Select one The effects of source-country environmental policies To a very significant extent (e.g., the EU’s Carbon-Adjustment Border Mechanism, the US Inflation Reduction Act, etc.) To a significant extent Ability to serve consumers in FDI host countries from To a modest extent FDI source countries via trade To a marginal extent Political stability in FDI source countries Don’t know Other (please specify) Please select the sectors you consider to be critical/ priority and for which you expect FDI in your country to substitute for imports: Select all that apply Sectors related to food security (e.g., agribusiness, fertilizers) Sectors related to health (e.g., vaccine production, pharmaceuticals, pharmaceutical ingredients, medical supplies) Critical raw materials (e.g., cobalt, lithium, aluminum) Semiconductors ICT/digital technologies Other (please specify) SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK None of the above 89 © MIGA, 2024 Appendix 1 Appendix 2 Literature review and supplemental data analysis SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 90 © MIGA, 2024 Appendix 2 Geopolitics and FDI relocations—a literature review The literature and commentary on geopolitics leading to economic fragmentation and the impact on the global economy focus principally on trade relations and supply chain dynamics, with comparatively less attention given to how foreign direct investment (FDI) flows are being affected. Nevertheless, there is emerging evidence that FDI, too, is responding to the economic and geopolitical fragmentation evident in recent years. Growing concerns over these trends have spurred multinational enterprises to consider bringing production closer to home. Driven by a desire to render supply chains more resilient to these trends, multinational enterprises are also increasingly considering strategies to relocate operations to reliable countries that share similar political views. These developments are likely to influence the evolving landscape of FDI. The increasing openness and stability of trade regulations in recent decades had motivated multinational manufacturers to establish global production chains under their ownership, situating different segments of the production process in different countries—frequently not close to the end users of the finished goods. Declining transportation and communication costs facilitated this development. The emphasis was on minimizing production costs through, for example, just-in-time production. There were occasional disruptions. For example, the earthquake and tsunami in Japan in March 2011 led to Japanese companies in the United States stopping production owing to a lack of parts and components from their Japanese suppliers (Javorcik 2020). Nevertheless, such disruptions were considered isolated incidents and led to only brief interruptions. The COVID-19 pandemic revealed the susceptibility of global supply chains to disturbances, which may become increasingly aggravated by climate change (Javorcik 2020). Furthermore, trade relations between the United States and China have raised concerns about a long-lasting wave of protectionism. Such developments are compelling multinational enterprises to rethink the location of their international production chains, aiming to increase resilience by sending FDI to different countries while also continuing to consider costs. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK FDI relocations may occur in response to reshoring, near-shoring, and friend-shoring. Following on from the International Monetary Fund (IMF 2023, 91), reshoring refers to a country’s transfer of all or part of the global supply chain back home, or geographically closer to home in the case of near- shoring. Friend-shoring limits supply chain networks and the sourcing of inputs to countries allied with the home country and to trusted partners that share similar values. However, friend-shoring may also entail shifts in investment—FDI relocations—with different effects on host countries. Looking at these categories from the perspective of international trade, UNCTAD (2024c) reported that the geographical proximity of international trade has remained relatively constant over the past two years, suggesting minimal near-shoring trends. Nevertheless, from the latter part of 2022, there has been a discernible increase in the political alignment of trade—that is, friend-shoring— with bilateral trade flows increasingly favoring transactions between countries with aligned geopolitical positions. From the perspective of FDI, teasing out geopolitically driven decisions from the strategic, economic, and other host-country factors considered by multinational enterprises when investing abroad is not straightforward. The IMF (2023c) examined the fragmentation of FDI along geopolitical divides and the rise of regional geopolitical blocs in the April 2023 World Economic 91 © MIGA, 2024 Appendix 2 Outlook. One finding was that the role of geopolitical distance in determining the inflow of FDI has notably increased in the past few years (figure AP2.1). Additionally, following Russia’s invasion of Ukraine, trade and FDI between different blocs decreased by approximately 12 percent and 20 percent, respectively, compared with trade and FDI flows occurring within blocs (Gopinath 2024). The increase in geopolitical distance is not solely attributable to trade relations between the United States and China. Competition and conflict are also affecting the direction of world trade flows, from the re-routing of Russian hydrocarbon shipments to the restrictiveness of shipping via the Red Sea, and these could bear on FDI relocations. In that context, Verisk Maplecroft, a research firm, highlighted the rising political and security risks in many developing countries that are additional considerations for FDI relocation via friend-shoring and near-shoring (Dobson and Roberts 2024). Additional evidence in the literature on FDI reshoring, near-shoring, and friend-shoring driven by geopolitical and economic fragmentation is relatively sparse (though more evidence is available vis- FIGURE AP2.1 FDI between geographically and geopolitically close countries, 2003–21 55 50 45 40 35 █ Geopolitical distance █ China FDI into the US 30 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Source: IMF 2023c, 96. Note: Figure shows the annual share of total FDI between country pairs that are similarly distant (that is, in same quintile of distance distribution), geopolitically and geographically, from the United States. à-vis trade and supply chains, for which multinational enterprise FDI actions play an important role; SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK see box AP2.1). Alfaro and Chor (2023) explored a looming “great reallocation” in supply chain activity from a trade perspective, also drawing on evidence from companies’ earnings calls since 2018. This indicated increased discussions about potential shifts away from China and toward Vietnam or Mexico (examples of friend-shoring and near-shoring). They presented supporting evidence of the decline of China as a preferred destination for greenfield FDI originating from the United States and other FDI source countries. Focusing on trade, Seong et al. (2024) found that China, Germany, the United Kingdom, and the United States have lowered the “geopolitical distance” of their trade—the degree to which trade partners are not aligned with domestic interests—by between 4 percent and 10 percent each since 2017. That report also underscored the sharp decline in announced greenfield investments into China and Russia compared with pre-pandemic figures and pointed out that increased greenfield FDI flows in some emerging markets, notably India, indicates potential changes in trade patterns. Della Posta (2022) postulated that friend-shoring and near-shoring, in contrast to reshoring, circumvents the geopolitical fragmentation while maintaining the economic gains of international production. 92 © MIGA, 2024 Appendix 2 UNCTAD (2024b) reported that geopolitical considerations are becoming more influential in determining where foreign investors locate, sometimes taking precedence over economic factors. Consequently, the predictability and openness of the global investment environment are diminishing. Aiyar, Malacrino, and Presbitero (2023) examined the impact of friend-shoring by using United Nations voting patterns as a proxy for geopolitical alignment between countries and comparing the evidence with data on greenfield FDI projects. They found that increased geopolitical distance between countries is associated with a significant decrease in FDI. This effect is even stronger for investments in low- and middle-income countries and in strategic sectors such as semiconductors, telecommunications, and 5G infrastructure; equipment for the green transition; pharmaceutical ingredients; and strategic and critical minerals. They also found that the importance of geopolitical alignment in FDI allocation has grown in recent years, especially since the resurgence of global commercial tensions. Reshoring, near-shoring, and friend-shoring may also be seen in a positive light, as strategies to enhance resilience. For example, Gereffi (2023) proposed that global value chains could become more resilient through reshoring or near-shoring by reducing the physical distances within supply chains through regionalized production. An example of the latter is locating production in Mexico and Central America for proximity to the United States. McLaughlin and Peterson (2023) referred to a “reshoring renaissance” taking place in the United States, driven by geopolitical tensions, among other factors, and importantly by industrial policies favoring domestic manufacturing, such as the US CHIPS and Science Act (The White House 2022). One example is TSMC Arizona, the largest FDI project in Arizona’s history (TSMC Arizona 2024). Analysis by Capital Economics, a research firm, indicates that there has been a significant boom in the construction of high-tech manufacturing plants in the United States, which is leading to a surge in technology output. Bellucci and Rungi (2023) reported a general reorganization of FDI strategies, with domestic subsidiaries more likely to be established and less likely to be divested, which could be interpreted as evidence of reshoring. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 93 © MIGA, 2024 Appendix 2 BOX AP2.1 The relationship between FDI and international trade Foreign direct investment (FDI) and international ent inputs or functions of the production process trade are closely interrelated, but research findings taking place in different countries exploiting the do not conclusively point to a direction of causality. competitive advantages of each location (efficien- Whether FDI complements or substitutes for trade cy-seeking FDI), may be considered as a comple- is contingent upon the characteristics of the invest- ment to trade. This is because such investment is ment itself. FDI that is used to establish productive accompanied by trade in intermediate inputs across facilities in a host country, essentially replicating the geographically dispersed value chains to produce operations in the home country with the purpose of the final product. Locations with lower trade barriers serving the host country’s market through domestic can be more attractive for efficiency-seeking inves- sales (market-seeking FDI), may be considered as tors, while free or preferential trade agreements, a substitute for trade. Such FDI may be driven by or more comprehensive agreements that include an escalation of transaction costs due to increased provisions aimed at facilitating investment flows, trade barriers and transportation costs, or to the can be attractive for both market-seeking and non-tradability of the final product (for example, efficiency-seeking FDI. Given the interdependence infrastructure services). between trade and FDI, disruptions in FDI flow pat- terns can have implications for trade patterns—and FDI that establishes global value chains, with differ- vice versa. Winners and losers The benefits of FDI for developing countries have been well documented in the literature, most recently by Ayenew (2022), Mejia (2023), and Izadi and Madirimov (2023). Reshoring, one of the trends we are discussing in this section, can suppress the flow of capital, technology, and know- how transfers that happen through FDI, denying potential investment locations those positive effects and spillovers. Góes and Bekkers (2022), using a model that incorporates dynamic, sector- SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK specific knowledge diffusion and diverging technology systems, found that a full decoupling of the global economy between East and West could reduce welfare effects by up to 12 percent in some regions, with the largest reduction in the lower-income regions. The IMF (2023) found that fragmentation in a world divided into two blocs centered around the United States and China (with some countries remaining nonaligned) could result in long-term losses of around 2 percent of global gross domestic product (GDP) with respect to FDI. Ahn et al. (2023) suggested that FDI may become more concentrated within blocs of aligned countries and that developing countries are at greater risk of being affected by FDI relocation compared with developed countries, partly due to their higher dependence on investment coming from countries that are geopolitically distant. UNCTAD (2024) cautioned that smaller developing countries, especially the least- developed countries, are facing increasing marginalization and vulnerability from global economic fracturing and shifting investment patterns. While not all implications of FDI relocations are negative, shifting patterns of investment (and trade) will create winners as well as losers. Relocating FDI will favor certain countries over others. Countries that can attract such investment, and in turn provide market access to the ultimate destinations—for example, through free or preferential trade agreements (Kox and Rojas- 94 © MIGA, 2024 Appendix 2 Romagosa 2020)—are likely to benefit. Researchers at Oxford Analytica (2023) highlighted the potential of Eastern Europe, for example, as a growing destination for FDI because of near-shoring decisions by EU countries. Capital Economics’ analysis sees the shifting of manufacturing supply chains into countries aligned with the United States—that is, friend-shoring—benefiting much of Southeast Asia and parts of Central and Eastern Europe and North Africa.1 Grieveson, Nechev, and Parkes (2023) explored the extent to which the European Union, through liberal trade relations with the Western Balkans and Eastern Europe, has succeeded in foreign policy alignment that would mark these countries as “friends,” leading to FDI relocation through near-shoring and friend-shoring there. In technologically advanced industries, such as semiconductors, South Korean companies are investing in the United States in response to friend-shoring (Shin 2024). Friend-shoring has also increased the prominence of Vietnam in global value chains, and as an FDI destination (Tafese, Lay, and Tran 2023). Countries likely to benefit less from these trends, or lose out entirely, are those that are already struggling to attract FDI because of poor location-specific factors, such as infrastructure and energy availability constraints; cumbersome FDI regulations; lack of investor protection; or inability to effectively access the domestic markets of the home countries, a universe that includes many low-income economies. Bolhuis et al. (2024) looked specifically at geopolitical fragmentation impacts on Sub-Saharan Africa, constructing an economic linkage index capturing the changing economic ties of the region with the EU-US bloc on the one hand and the China–emerging markets bloc on the other, and including trade openness, external flows (FDI inflows and official development assistance), and total external debt. The findings indicate that over the past 20 years, Sub-Saharan Africa has shifted its economic connections from predominantly established partners to increasingly new partners. Considering these developments, establishing an environment conducive to attracting FDI is crucial, as this could enable countries to leverage restructuring of global supply chains to include like-minded partners. Additionally, minimizing domestic policy uncertainty through better governance can lower the perceived risk of the country. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK Geopolitical fragmentation is becoming more evident in FDI policies. Governments in developed countries are increasingly focusing on national security considerations when vetting potential inward investment, or other policies and measures that can place barriers in the way of foreign investors. While some developing countries continue to loosen restrictions on inward investment, with measures such as increasing foreign equity ownership ceilings, opening closed sectors to FDI, facilitating permits for foreign workers, and improving land ownership rights, others are also increasingly implementing screening mechanisms for national security (figure AP2.2). 1 Capital Economics, Emerging Markets Economic Update, March 11, 2024. 95 © MIGA, 2024 Appendix 2 FIGURE AP2.2 World Bank FDI entry and screening tracker—FDI measures by type  Barriers to investment entry Screening mechanism-National Security sectors 33 911 Other sectoral screening mechanism 5 4 1 Restriction on hiring foreign workers 4 2 11 Screening mechanism-Net Benefits 7 Screening mechanism-only Healthcare sector 6 █ OECD member Reducing foreign capital ownership 111 █ Europe and Central Asia Screening mechanism-Bordering Countries 1 █ East Asia and Pacific █ Latin America Restriction to work permit 1 and Caribbean █ Middle East Restriction on land ownership 1 and North Africa █ Sub-Saharan Afica Restriction to foreign investor residence permit 1 █ South Asia Other measures 1 Source: FDI Entry and Screening Tracker, World Bank, 2023 While pressures might be building on multinational enterprises to switch investment patterns away from unstable or unfriendly countries and regions, considerable pressures exist in the other direction, namely, to preserve existing investment commitments. In that regard, the ease with which FDI relocations can take place is unclear. Freund et al. (2023) found that while US-China decoupling in trade is taking place, supply chains remain intertwined with China, suggesting that the cost of disengaging from established locations may be significant and might involve forgoing substantial commercial opportunities, perhaps ceding them to competitors. Practices associated with globalization, such as “just in time,” would have to be reestablished in the new locations, SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK which would entail additional costs—although automation and digitalization may facilitate the process. Kouam (2024) found only a small increase in the number of US companies intending to relocate from China either back to the United States or to other countries between 2016 and 2020, with the overwhelming majority (87 percent) intending to remain in China. While geopolitical trade tensions have created uncertainty in the business environment, decisions to relocate to other countries may be based on diverse and potentially interlinked factors, including costs. The attraction of large and growing markets for goods and services is another consideration for preserving existing investments. Despite sluggish domestic growth in recent years, China remains an attractive market. Understandably, multinational enterprises would be keen to invest in production to supply burgeoning domestic demand, and this may be a disincentive for relocation. 96 © MIGA, 2024 Appendix 2 Ultimately, the extent to which FDI relocations will occur on a significant scale will be influenced by whether the economic and geopolitical fragmentation and trade tensions are perceived as sufficiently large and persistent. If the geopolitical fragmentation and trade tensions present today become entrenched, FDI relocations have the potential to accelerate and intensify. Business factors, such as corporate strategies, costs, competition, and sector- or firm-level considerations, as well as the economic fundamentals or “location advantages” of host countries (Dunning 2001), will still play important roles in deciding where to locate. Added to those will be whether the host country is considered “friendly” by its leading sources of inward investment, and a reassessment of the advantages owing to its geographical proximity or preferential access to final consumption markets, in light of the recent experience of substantial supply chain disruptions (including because of the COVID-19 pandemic). Put differently, if geopolitical alignment becomes an important concern, the likelihood of FDI relocation increases. SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 97 © MIGA, 2024 Appendix 2 FDI between the United States and China FDI flows between the United States and China have weakened in recent years (figure AP2.3), driven in part by government policies intended to limit mutual dependence. At the same time, these trends are recent, and it may be too soon to draw firm conclusions. For example, FDI by the United States into China amounted to $35.2 billion in the five years to 2023, down nearly 12 percent from the prior five years.2 The pandemic and its after-effects were responsible for some of this decline. Specifically, FDI flows into China from the United States, as reported by the US Bureau of Economic Analysis, turned slightly negative in 2021 as the effects of the pandemic intensified. Although FDI bounced back in 2022, the average for the two years was likely less than it would have been absent the pandemic. The investment picture was much worse in the other direction: FDI inflows from China into the United States fell to negative $7.5 billion during the five-year period to 2023 (as all figures are on a net basis, this points to some combination of divestment of Chinese assets in the United States, repatriation of profits or repayment of intra-company loans). Indeed, net Chinese inflows to the United States were negative each year from 2020 to 2023, suggesting that something more than the effects of the pandemic was occurring. These were the first negative years of Chinese FDI into the United States since 2003 and support the view that US policies intended to discourage certain kinds of Chinese investment are having an effect. FIGURE AP2.3 United States–China FDI flows, 2003–23, $ millions China’s FDI flows 20,000 into the United States have 15,000 plummeted 10,000 SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK 5,000 0 █ US FDI into China -5,000 █ China FDI into the United States -10,000 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: US Bureau of Economic Analysis. 2 China’s National Bureau of Statistics measures FDI differently, but it still shows a decline in US FDI into China in recent years compared with the late 2010s. 98 © MIGA, 2024 Appendix 2 FIGURE AP2.4 United States–China international trade flows, 2008–23, $ millions Bilateral trade 600,000 between the US and China remains 500,000 strong 400,000 300,000 200,000 █ US exports of G&S to China 100,000 █ US imports of G&S from China 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: US Bureau of Economic Analysis. Note: G&S = goods and services. Trade between the United States and China has been somewhat more resilient, but this picture masks stabilized US exports to China and a decline in imports (figure AP2.4). Annual US exports of goods and services to China grew by just 3.7 percent overall during the seven-year period between 2017 (when trade tensions began to surface) and 2023 (to $194.7 billion from $187.9 billion).3 By comparison, US exports to China grew by 44 percent during the prior seven years, from 2011 to 2017 (to $187.9 billion from $130.7 billion). Trade in the other direction tells a similar story. US imports of goods and services from China, though more than twice as high as US exports to China, amounted to $448 billion in 2023, down 20 percent from the year before and down by around 15 percent from 2017; 2023 was the first time Chinese exports to the United States were below $450 billion since 2012.4 FIGURE AP2.5 FDI data for the European Union5 show a European Union–China FDI flows, 2013–17 vs. 2018–22 decline in both outbound and inbound flows Bilateral FDI flows 80,000 with China (figure AP2.5). FDI from China to SHIFTING SHORES: FDI RELOCATIONS AND POLITICAL RISK between the EU 70,000 the European Union in 2018–22 dropped 3.2 and China have slowed 60,000 percent from 2013–17 (to $24.8 billion from 50,000 $25.7 billion). EU FDI outflows to China fell 40,000 30,000 much more, by 37 percent (to $44.6 billion 20,000 from $70.7 billion) between the respective █ 2013-17 10,000 periods. As with the United States, annual █ 2018-22 0 flows between the European Union and China China to EU EU to China Source: OECD Data Explorer. Note: EU figures cover 21 large member economies.   have been volatile, and it is difficult to separate out both the immediate effects of the pandemic and any lasting consequences. This much, however, is clear: direct cross-border investment between the West and China, measured in five-year blocks, has dropped substantially over the last decade. 3 The United States began imposing the first in a series of tariffs on Chinese imports in January 2018. China in most cases reciprocated. 4 All data in this paragraph are from the US Bureau of Economic Analysis. 5 EU FDI data are from the OECD and comprise 21 large EU economies. The United Kingdom is excluded from all years. 99 © MIGA, 2024