How foreign investments can drive efforts towards a green recovery

The outlook for foreign investment is beginning to brighten after more than a year of acute economic shocks caused by COVID-19. The pandemic has had a severe impact on output and trade, and caused global foreign direct investment (FDI) flows to plummet by more than 40 per cent. While global trade rebounded in the second half of 2020, FDI remained weak. With the global economy expected to grow by 4 per cent in 2021, however, foreign investors may be ready to plan for future expansion – with caution.

The World Bank’s Global Pulse Survey of multinational enterprises (MNEs) has been tracking how MNEs1 that operate in developing countries have experienced and responded to the crisis. MNEs are the lead firms in global value chains, and are responsible for as much as 80 per cent of global trade. In 2019, MNEs accounted for one-third of global private sector output, and employed an estimated 80 million people, including many who live in developing countries. As countries begin moving towards recovery, foreign investment by MNEs has the potential of playing a significant role in the creation of jobs and in boosting productivity. 

The results of the latest MNE Pulse Survey indicate a stabilization of MNE investment outlook compared with earlier rounds of the survey in 20202. Three-quarters of respondents surveyed in the fourth quarter3 (October-December 2020) expected to maintain their current level of investment, and very few anticipated reductions in investment. MNEs also reported limited plans for a major reorganization of investment locations, business models or supply chain structures. Still, the pandemic has ushered in a period of momentous change, with many firms reporting that their use of technology has increased and that their focus on environmental sustainability has intensified since the outbreak of the crisis.

Considerable uncertainty about the course of economic recovery remains. FDI has the potential to support recovery by creating jobs and boosting productivity. To realize this potential, however, countries must have appropriate FDI policies in place that will enhance their competitiveness and give firms the confidence to invest in them.

Stabilizing Foreign Direct Investment

Following a steep decline in FDI in 2020, investors are still waiting on the sidelines. FDI data indicate that the pipeline for greenfield investment is limited. The value of new greenfield FDI announcements in developing countries plunged in 2020, and remained more than 50 per cent below the 2019 levels in the fourth quarter.

The downturn in investment should come as no surprise given the significant disruptions and impacts on profit firms have experienced throughout 2020. Despite a gradual overall improvement, the survey revealed that the pandemic’s adverse effects were still palpable in the fourth quarter of 2020, with over 90 per cent of respondents reporting that at least one of their firm’s business dimensions (such as revenue, workforce productivity or supply chain reliability) had been adversely affected.

Survey data also, however, indicate that the near-term outlook for foreign investment is stabilizing. In the previous survey round4 (third quarter of 2020), 39 per cent of respondents claimed that their parent company planned to invest less. In the most recent round, this share was only about 1 per cent, suggesting that MNEs’ earlier negative outlook may have been driven by short-term investment plans.

Nonetheless, only few MNE affiliates are planning to expand their investments over the next one to three years. Three quarters of firms reported that investment levels were expected to remain the same (up from 46 per cent in the third quarter), while 17 per cent anticipated investments to increase (up slightly from 13 per cent in the third quarter).

Policies, Growth and Costs Remain Key to Competitiveness

Looking ahead, one major challenge for countries will be which steps to take to bolster their competitiveness and attract new investments to support their recovery. On this front, survey data confirm what the literature has consistently shown: FDI policies play a crucial role in shaping countries’ attractiveness as investment destinations. Among MNE affiliates that expect their parent companies to invest more in the host economy in coming years, 86 per cent stated that expected or realized changes in the country’s investment policy environment was a driver of their expansion plan.

With prospects of global recovery expected to be uneven, MNEs are also significantly driven by shifts toward countries that offer larger markets or faster growth opportunities. Three-quarters of respondents mentioned this as their motivation to expand their investment. Cost competitiveness of host economies also continues to remain a major driver of MNEs’ investment plans, with over half of respondents citing this as their motivation to increase investment. Some investment decisions are, to a lesser degree, motivated by diversifying production locations and adjustments in global value chains aimed at nearshoring or reshoring.

The near-term outlook for foreign investments may be stabilizing, but will continue to remain highly competitive. Countries should therefore use the COVID-19 crisis as an opportunity to reform their trade and investment policies and boost investor confidence in order to attract the necessary foreign investment capital to underpin their recovery.

Technology adoption and a growing focus on sustainability

Adapting to the challenges created by the pandemic, the vast majority of respondents (91 per cent) reported increased use of digital business-to-customer (B2C) tools, such as e-commerce and digital engagement. Most firms (88 per cent) also cite higher use of digital management tools, either to support staff working remotely, or to manage and monitor supply chains. These findings align with the results of prior rounds of the MNE Pulse Survey, and we find that the incidence of technology adoption has increased throughout the year.

A growing global focus on sustainability, the threat of climate change, and the need for a ‘green recovery’ has played out alongside the pandemic. Accordingly, approximately three-quarters of MNE affiliates reported having taken steps to increase sustainability and to decarbonize their products and services. The focus on sustainability was particularly prevalent in manufacturing. This suggests an acceleration of climate change awareness among firms in sectors that are frequently carbon intensive.

Supporting a green, inclusive and resilient private sector-led recovery will require substantial investments in all forms of capital, as well as the transfer of technology solutions. This entails a crucial role for FDI, which is often the largest source of external capital for developing countries and enables the transfer of technologies. FDI policies, which fall within the remit of governments, will be important to facilitate private sector investments that contribute to environmentally sustainable  growth and economic transformation for a robust and resilient recovery.