Declining foreign direct investment can’t contribute much to sustainable development

Tegucigalpa, Honduras.- In the photos taken on January 15, 2021, people work at a food plant in Tegucigalpa. Honduras received 323.5 million dollars of Foreign Direct Investment (FDI) during the third quarter of 2020, 75.9% higher than the same period of 2019, according to the Central Bank (BCH).

As multinational corporations are perceived as having ever-growing reach and sophisticated international value chains crisscross the planet, governments and civil society are demanding that international business do more to advance sustainable development and to tackle climate change.

This begs the question of what private-sector engagement—through foreign direct investment (FDI) decisions and other business conduct—has contributed to the globally agreed-upon Sustainable Development Goals.

While there is a vibrant and necessary debate about the mechanisms through which FDI affects host economies, on the whole, developing countries have enjoyed economic benefits from greenfield investments and reinvestment in the existing stock of FDI. But what of the social and environmental benefits?

Looking back over the past quarter of a century, the 27th Global Trade Alert report puts current FDI dynamics in perspective, uses the latest data on policy interventions to assess the degree to which governments continue to favor FDI, and points the spotlight on the limited contribution of FDI to advancing sustainable development in emerging markets. What follows is a summary of some key findings.

FDI in developing countries falters

Companies are resorting less and less to FDI. Once a hallmark of globalization, FDI has been in trouble for some time—a fact compounded by the ongoing pandemic:

  • Even before last year’s 42 percent drop, sensibly benchmarked annual inflows of FDI have been in decline since the global financial crisis.
  • The economic fallout from COVID-19 has resulted in new FDI flows retreating to levels not seen for 25 years.
  • Globally, the average return on FDI fell during the past decade. Mean FDI returns fell more in developing countries than in higher-income countries.
  • Since 2015, U.S. multinationals have earned at most meager additional returns from FDI in developing countries (outside of the Middle East) when compared to investments in less risky European Union economies.
  • Returns on U.S. FDI in educational services are so low it would take 40 years to recoup their outlays. Worse, the payback period for investments in health and telecoms is over 90 years. Fortunately, returns from investing in manufacturing are healthier.

According to the World Investment Report 2020, a total of $11.3 trillion of foreign direct investment has been made in developing countries up until the end of 2019. Each year, some of that capital will depreciate and need to be replaced. With a 3.9 percent depreciation rate, this implies that annual FDI inflows into developing countries must exceed $440 billion just to replace the FDI capital that has worn out and ceased to be commercially useful. Considering the low FDI premia reported earlier, whether multinational enterprises are prepared to commit to such substantial outlays in the future is the central question.

Falling returns on FDI in developing countries are the canary in the coal mine— they call into question the commercial viability of setting up shop in foreign markets and retaining operations there. Risk adjustments would lower FDI returns in emerging markets even further.

Policy toward FDI must be reset

With over $11 trillion invested in developing countries, both international business and governments have a huge stake in reviving the commercial fortunes of FDI. To date, too much of the onus has been on international business. For example, the private sector has been told by advocates of sustainable development to “align” with the global and societal transformations needed to accomplish the Sustainable Development Goals.

Those advocates and policymakers must reflect and act on why the returns to FDI in key sectors are so low and why only a trickle of FDI inflows has occurred in them. Enhanced corporate contributions to sustainable development should be balanced by policy reforms to restore the commercial viability of FDI in developing countries—a proven mechanism to transfer management expertise, people, capital, and technology.