Global Foreign Direct Investment – Drivers & Beneficiaries

Historically investment has gone where economic incentive and returns are best, which in turn has driven specialisation, innovation and trade.

Venice, the richest and most successful European economy from the 11th to the 16th century, used economic incentives to attract foreign investment. Venice created the institutional foundations for commercial capitalism by guaranteeing property rights and the enforceability of contracts. This combined with an efficient fiscal system that was favourable to merchant profits encouraged capital accumulation and specialisation while keeping costs low.

The Dutch Republic’s ascent in the 14th century was underpinned by the same model as Venice’s, as was the industrialisation of countries that followed. Each became a magnate for FDI. In early 1500 England adopted the Dutch economic model of industrial specialisation supported by a sound legal, financial and tax system.

Historically, foreign capital and entrepreneurs have played crucial roles in transferring technology and in helping drive local innovation. Britain is credited as the father of the industrial revolution but all the major innovations that drove the initial British industrial expansion came from the technically more advanced countries at the time - Germany, The Netherlands, Italy and France.

In the United States, the rapid transfer of technology from Britain, along with expanding trade and inward investment—coupled with America's abundant land and mineral resources—accelerated its industrialisation. By 1913 it was the US not Britain that operated closest to the technological frontier.

The rest is history – the rise of Japan, starting 1868, the Asian Tigers and China in the late 1970s.

Foreign direct investment flows

Figure 1 shows that while global FDI tend to be volatile from year-to-year, FDI as a share of global GDP, has risen through recessions, crises, geopolitical tensions, trade battles and wars. The exceptions are the Global Financial Crisis, the worst financial market meltdown since the 1929 crash, and the pandemic, when economies ground to a halt.

The bulk of FDI outstanding is concentrated in advanced economies, Europe and North America, of which the lion’s share is in the US.

The decline in Europe’s share between 1990 and 2023 is striking in Figure 2. Europe’s waning attractiveness for foreign direct investment cannot be attributed solely to demographics. The working-age population (16-65 years) makes up 63.8% of the total in the EU, compared to 61.9% in the US, so demographics alone can't explain the trend. Instead, high production costs, labour market inflexibility, and increasing regulatory and bureaucratic barriers to entry are the real culprits.

In contrast, the US has strengthened its position. It’s share of global FDI outstanding has increased from 24.6% in 1990 to 20.6% in 2023. Asia also stands out among emerging markets. Companies have been drawn by comparative cost advantages, by favourable policy incentives and the regions rising consumer purchasing power.

Figure 3 shows average FDI inbound flows by decade and in the three years to 2023. While Asia, led by China, once again stands out in claiming an increasing share of global FDI flows, it is the speed of Europe’s collapse as a destination that is remarkable especially compared with America’s continued attractiveness to investors.

The US through the decades has remained the top destination for foreign direct investors. This is evident looking at FDI flows per capita, an even more accurate gauge of relative attractiveness (Figure 4).

The US dominates

In the US it was not until the late 1970s that inward FDI took off (Figure 5). Instrumental in enhancing the attractiveness of the US for foreign companies were – the 1978 Airline Deregulation Act, allowing carriers to set fares and routes freely. The 1980 Motor Carrier Act and Stagger Rail Act, deregulated the trucking and railroad industries, lowering shipping costs.

Reaganomics added momentum. Regulations were aggressively rolled back across multiple industries, including finance, energy, telecommunications, transportation, and labour markets. The top rate income tax rate was cut long with corporate and capital gains tax rates.

Subsequent administrations have continued to strengthen the America's appeal as an investment destination. Neither Trump 1.0 nor Biden’s climate policies, worker protections and financial regulations—which have increased costs and compliance burdens on companies—have deterred inward investment. In 2023, overseas companies invested US$349bn in the US, and another US$285bn in the first three quarters of 2024, which is a 13% increase on the same period a year earlier.

By country of the ultimate beneficial owner, the largest foreign direct investors were Japan, Canada, Germany and the UK. Market size and consumer affordability do matter but history shows knowledge, innovation and specialisation tend to cluster around leading economic hubs. For investing companies, these established centres offer the highest chances of success, growth, and profitability. Returns on capital are high where capital is already abundant, as is the total stock of knowledge in an economy.

And the US is certainly delivering on that for foreign companies. The ratio of income to investment for foreign companies in 2023 was 5%. This compares with 3.3% in 1987. Over the past 36 years income has risen by a cumulative 3000% and foreign direct investment positions by 1948% i.e. investing in the US must have been well worth the punt.

Conclusion

Expect FDI flows to the US to rise as the Trump unleashes a deregulatory wave and foreign companies relocate. China is still attractive for two reasons. First, because knowledge spillovers cannot be contained. Second, Beijing’s determination to attract foreign investors.