The FDI earthquake you probably missed, and what it signals for global trade
David Dodwell says some of the reasons for the 23 per cent drop in foreign investment worldwide last year – such as Trump’s tax reform and ‘America first’ protectionism – will persist for some time, and this means their impact should not be ignored
With all the excitement around the Trump-Kim summit in Singapore, open hostilities among G7 members in Montreal, and the World Cup, a fascinating and important bit of news almost escaped my attention: last year, foreign investment worldwide fell by a shocking 23 per cent.
Even more striking: foreign investment flows into the United States slumped by 40 per cent, from US$457 billion to US$275 billion, and by 42 per cent into the European Union, from US$524 billion to US$304 billion.
This investment earthquake meant that Asia was the world’s most important destination for foreign investment, with its share, steady at US$476 billion, accounting for 33 per cent of global flows (compared with 25 per cent in 2016). China (attracting US$136 billion) and Hong Kong (attracting US$104 billion) remain the world’s second- and third-most-important destinations for FDI, after the US.
Perhaps it should be no surprise that this dramatic news was missed. It appeared in what is among the world’s most boring “bibles” – the UN Conference on Trade and Development’s (UNCTAD) annual world investment report. As I plough through its 200 pages of turgid text and inscrutable tables, I believe I am one of a minority of human beings to ever turn its pages.
Yet its insights are fascinating. What could have happened to trigger such a precipitous fall in foreign investment – from US$1.87 trillion in 2016 to US$1.43 trillion last year?
The first reason is boring: there happened to be a number of international “mega deals” in 2015 and 2016 that inflated flows in those years. These did not happen in 2017, and so total FDI fell back.
Watch: China and the US put trade war on hold ... for now
The second reason sparks more interest: the global uncertainty over international trade, fuelled by White House rhetoric and threats of trade wars and tariff increases, may have suppressed enthusiasm to invest overseas. Pressure to put “America first” and bring jobs back home to the US has apparently succeeded in prompting many US multinationals to invest afresh back home.
The third reason should have been obvious to me, but caught me by surprise – the tax reforms in the US, providing tax relief on repatriation of funds, which came into effect at the beginning of this year, have prompted large numbers of US companies to radically rethink their investment strategies. Profits that have for years been held offshore for tax reasons (and invested in operations outside the US) can at last return home on favourable tax terms.
UNCTAD’s researchers says the tax measures will free up more than US$3.4 trillion in accumulated overseas retained earnings which could be repatriated. That could skew US FDI flows for some time to come.
Finally, the researchers noted that multinationals’ profit margins overseas are in decline. Average rates of return on foreign investment have slipped from 8.1 per cent in 2012 to just 6.7 per cent last year. In short, the profit-seeking incentive to invest overseas has declined quite sharply.
There is every reason to think that these factors will persist this year and beyond, as it seems clear that the turbulence created by America’s “new protectionism” is likely to have long-term, rather than just passing, impact. Political pressure inside the US is forcing many US companies to shorten and simplify the long production value chains that have developed over the past three decades of globalisation. Increasingly, their investments overseas will be driven by local market demand.
Recent ramped-up scrutiny by the US, and in particular the Committee on Foreign Investment in the US (CFIUS), on possible security risks arising from Chinese corporate investment in north America, and on national security dangers arising from Chinese companies buying state-of-the-art IT components, has also cramped China’s ambitions to invest overseas, and persuaded Beijing to double down on efforts to make sure critical technologies are developed at home, minimising reliance on imported components.
Watch: US hits Chinese telecoms giant ZTE with components ban
This seems likely to encourage Chinese companies to shorten their production chains, bring more high-value-adding activity onshore, with an inevitable impact on international trade. This is not visible yet: world trade continued to grow last year. But the writing seems to be appearing on the wall.
As the UNCTAD report notes: “Significant tensions have emerged in global trade, encompassing a number of major economies. The resultant atmosphere of uncertainty could cause [multinationals] to cancel or delay investment decisions until the trade and investment climate is more stable.
“If tariffs come into force, trade and global value chains in the targeted sectors will be affected and so, consequently, would be efficiency-seeking FDI.”
A number of idiosyncratic factors also muddied last year’s FDI numbers. Foreign investment into Britain slumped from US$196 billion in 2016 to a meagre US$15 billion last year. UNCTAD simply referred to an “anomalous” peak in 2016. At the same time, outward investment from the UK soared from a negative US$23 billion in 2016 to a positive US$100 billion last year. Whether these gyrations had anything to do with Brexit uncertainties was not clear.
Meanwhile, outbound investment from China also fell (for the first time since 2003) by 36 per cent – from US$196 billion to US$125 billion – for reasons we in Hong Kong noted only too well: “The result of policies … in reaction to significant capital outflows during 2015-16, mainly in industries such as real estate, hotels, cinemas, entertainment and sports clubs”. These curbs seem to have been relaxed of late, so perhaps we can expect an upturn this year.
Reading between UNCTAD’s turgid but information-dense lines, I sense some important shifts occurring that may have a long-term impact on trade and investment both in Asia and worldwide. You learned it first in the world investment report – if you managed to stay awake reading it.
David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view