Global political and economic shifts demand strategic FDI responses

Global trading rules and supply chains have been turned upside by a combination of factors, including geopolitics and ESG regulations. But how should governments and companies respond? By Martin Kaspar and Douglas van den Berghe.

Even if we cannot agree on the extent to which deglobalisation is happening, or whether we are merely regionalising into trading blocs (e.g. the European Union, Regional Comprehensive Economic Partnership, United States-Mexico-Canada Agreement), what cannot be disputed is that the economic world is changing dramatically.

What are the factors that have led to this new economic landscape?

Three key factors have shaped the depth and interconnectedness of the global economy: geopolitics; technological developments; and government policy/regulation. There is nothing new in this. What has changed is the vehemence with which geopolitical tensions, digitalisation, and global crises are reshaping our world. The question is: are we in such troubled waters that corporate executives need to understand as much about geopolitics as about their own products?

Companies are impacted by global changes in significantly different ways. While small and medium-sized enterprises are much harder hit, multinationals can essentially side-step most of the effects. Manufacturing companies, which are strongly integrated into global value chains, tend to be more exposed to foreign supply shocks and protectionist threats (e.g. the breakdown of supply chains due to harbour closures in China or the Houthi attacks).

In particular, companies in smaller, open economies (such as France, Germany and the Netherlands) are heavily affected by market- or supply-side disruption, while those in the US or China benefit from much larger domestic markets.

Geopolitics

Perhaps the biggest risk stems from the geopolitical tensions between the West and China, which have led to a fundamental reassessment of global supply chains. Terms like ‘decoupling’ or ‘de-risking’, unheard of only a few years ago, are now informing the debate.

While Western political elites talk about the need to avoid decoupling and maintain free trade, high-tech products and rare earths are already subject to outward FDI screening and trade limitations. Companies are diversifying their supply chains away from China, driving investment towards Vietnam, Thailand, and India – a phenomenon known as China+1.

At the same time, Belt and Road investments are being met with growing concern and scrutiny in the West. With countries increasingly resorting to protectionist measures, trust in international markets is being eroded and cross-border investment is declining.

Digitalisation and technology

The technologies of the so-called Fourth Industrial Revolution, such as IoT, AI, Big Data and automation, are revolutionising manufacturing and logistics. By largely removing labour costs, manufacturing is now possible in high-wage countries again. This is a development that has the potential to fundamentally alter trade and FDI flows.

Policy changes: Environmental, social and governance (ESG)

The Western emphasis on ESG could throw current trade flows and FDI decision-making criteria into disarray. The compliance costs of ESG legislation is particularly challenging for SMEs. Draconian penalties for non-compliance, will – quite probably – result in companies shunning countries considered as “problematic” (i.e. developing countries due to regulatory voids and low transparency rankings). With Industry 4.0 a relocation towards the West is now feasible, and much less risky than being active in countries that cannot provide Carbon Border Adjustment Mechanism values, or Corporate Sustainability Due Diligence Directive (CSDDD) assurances.

What does this mean for FDI?

The consequences of fracturing global value chains and a rules-based world are unpredictable. Companies are restructuring their supply chains towards a more diversified supply base. It seems reasonable that they want to manufacture closer to home. However, the reverse also holds true, with corporates going for a “local-for-local” strategy, to take geopolitics out of the value chain. So, despite a protectionist surge and xenophobia on the rise, we are seeing investments in foreign countries (e.g. Chinese automakers investing in the US and Europe to side-step local content hurdles).

Countries with low-cost labour could see their business model go up in flames within a decade as robotisation and automation take off, and through ESG developments making it less attractive for companies to continue production in these countries.

As for the effects of climate policy, either European economies are propped up with incentives (similar to the Inflation Reduction Act in the US), or they need to start relaxing some of the draconian climate legislation. Otherwise there is a risk of this becoming not only an economic problem, but a democratic one.

We are living through multiple paradigm shifts. Consequently, it is difficult to spot consistent patterns in these changes. If there is one consistent point in all of this, it is the fact that companies will seek to ensure predictability and transparency. But given that we cannot even fully agree on what the danger is, predicting the outcome is even more difficult.

Some are pulling back from emerging countries, due to political concerns (being caught up in trade wars) and ESG legislation (non-compliance with CSDDD). Others are going in the opposite direction (Chinese companies setting up manufacturing sites in Europe and USMCA to avoid being barred from Western markets).

Rules-based trading system

Companies might easily be caught between international and national policy pressures. But rather than wielding moral sticks, we should focus on salvaging the basic infrastructure of a rules-based global trading system, to create at least some modicum of stability in international trade and investment.

How can countries succeed in this new era? In the changed macro-economic context, FDI will no longer be a panacea for every country for economic development, especially as some countries will be left out of the FDI circuit.

What can these countries do? They can focus on exports, albeit this is difficult in a protectionist era. They could build a national industry and an entrepreneurial ecosystem, focusing on a domestic, or regional market. This is essentially what China, the EU and the US are already starting to do.

Governments that want to stay in the FDI game (and there are lots of good reasons for this) need to strengthen their investment promotion efforts and their network of free trade agreements, to create a more predictable context for cross-border trade and investment.

Governments must respond

FDI flows can be improved through better investment promotion – in particular strengthening the facilitation of investment – and by supporting corporate managers in navigating the increasingly complex regulatory environment.

Governments must aspire to be the antidote to instability, creating a predictable and transparent business environment and minimising corporate risks. They must focus on infrastructure development and connectivity to support the investment and reshoring activities of highly automated, data-driven manufacturing.

Most important, however, there is a need to resuscitate the international organisations that guard and protect the orderly conduct of international trade and investment. This requires forward-thinking policymakers willing to depart from ideological lines (e.g. geopolitics, ESG standards) and work on solutions.

Martin Kaspar is head of business
development at a German Mittelstand
company in the automotive industry. 

Douglas van den Berghe is founder of NxZones, a global network of special economic zones, technology parks and eco-industrial parks.