（英文）行业资料IMF-World Economic Outlook,April 2023 Chapter 4-report 2023-04-06

CHAPTER

GEOECONOMICFRAGMENTATIONANDFOREIGNDIRECTINVESTMENT

4

Supply-chaindisruptionsandrisinggeopoliticaltensionshavebroughttherisksandpotentialbenefitsandcosts

ofgeoeconomicfragmentationtothecenterofthepolicy

debate.Thischapterstudieshowsuchfragmentationcanreshapethegeographyofforeigndirectinvestment(FDI)and,inturn,howFDIfragmentationcanaffectthe

globaleconomy.TherecentslowdowninFDIhasbeen

characterizedbydivergentpatternsacrosshostcountries,withflowsincreasinglyconcentratedamonggeopoliticallyalignedcountries,particularlyinstrategicsectors.Severalemergingmarketanddevelopingeconomiesarehighly

vulnerabletoFDIrelocation,giventheirrelianceonFDIfromgeopoliticallydistantcountries.Inthelongterm,

FDIfragmentationarisingfromtheemergenceofgeopolit-icalblocscangeneratelargeoutputlosses.Theselossesmaybeespeciallysevereforemergingmarketanddeveloping

economiesfacingheightenedrestrictionsfromadvanced

economies,whicharetheirmajorsourcesofFDI.Mul-

tilateraleffortstopreserveglobalintegrationarethebestwaytoreducethelargeandwidespreadeconomiccostsofFDIfragmentation.Whenmultilateralagreementsarenotfeasible,multilateralconsultationsandprocessestomiti-gatethespillovereffectsofunilateralpoliciesarerequired.Inamorefragmentedworld,somecountriescouldreducetheirvulnerabilitybypromotingprivatesectordevelop-

ment,whileotherscouldtakeadvantageofthediversionofinvestmentflowstoattractnewFDIbyundertak-

ingstructuralreformsandimprovinginfrastructure.

Introduction

Risinggeopoliticaltensionsandtheunevendistri-butionofthegainsfromglobalizationhavecontrib-utedtoincreasingskepticismtowardmultilateralismandtothegrowingappealofinward-lookingpolicies(ColantoneandStanig2018;Rodrik2018;Autor

TheauthorsofthischapterareJaeBinAhn,BenjaminCarton,

AshiqueHabib,DavideMalacrino,DirkMuir,andAndrea

Presbitero,undertheguidanceofShekharAiyar,andwithsupportfromShanChen,YouyouHuang,CarlosMorales,ChaoWang,andIlsePeirtsegaele.ThechapterbenefitedfromcommentsbyRichardBaldwinandseminarparticipantsandreviewers.EswarPrasadwasaconsultantfortheproject.

andothers2020;PastorandVeronesi2021).Brexit,

tradetensionsbetweentheUSandChina,andRussia’s

invasionofUkraineposeachallengetointernational

relationsandcouldleadtopolicy-drivenreversalof

globaleconomicintegration,aprocessreferredtoas

geoeconomicfragmentation.Thisprocessencom-

passesdifferentchannels,includingtrade,capital,

andmigrationflows.1Thischapterfocusesonone

specificchannel—thefragmentationofforeigndirect

investment(FDI),whichiscross-borderinvestment

throughwhichforeigninvestorsestablishastableand

long-lastinginfluenceoverdomesticenterprises.

Aslowdowninglobalization—oftenreferredtoas

“slowbalization”—isnotnew.Formostcountriesit

datestotheaftermathoftheglobalfinancialcrisis

(Antràs2021;Baldwin2022).AdecreaseinFDIhas

beenparticularlyvisible,withglobalFDIdeclining

from3.3percentofGDPinthe2000sto1.3percent

between2018and2022(Figure4.1;seealso

UNCTAD2022foranoverviewofrecenttrendsin

FDI).Whilearangeoffactorshavecontributedtothis

protractedphaseofslowbalization,thefragmentation

ofcapitalflowsalonggeopoliticalfaultlinesandthe

potentialemergenceofregionalgeopoliticalblocsare

novelelementsthatcouldhavelargenegativespillovers

totheglobaleconomy.

Firmsandpolicymakersareincreasinglylookingat

strategiesformovingproductionprocessestotrusted

countrieswithalignedpoliticalpreferencestomake

supplychainslessvulnerabletogeopoliticaltensions.2

1Aiyarandothers(2023)presentsignsofgeoeconomicfragmen-

tationalongdifferentdimensions(forexample,trade,capitalflows,

andreassessmentsofgeopoliticalrisk),analyzeseveralchannels

throughwhichsuchfragmentationcouldpropagatethroughthe

globaleconomy,anddiscusshowtherules-basedmultilateralsystem

mustadapttothechangingworld.SeetheApril2023Global

FinancialStabilityReportforananalysisoftheeffectsofgeoeco-

nomicfragmentationonnon-FDIflows,withimplicationsfor

financialstabilityandmacrovolatility.

2Theterm“reshoring”referstoacountry’stransferof(partofthe)

globalsupplychainbackhome(orgeographicallyclosertohomein

thecaseof“nearshoring”).“Friend-shoring”limitssupply-chainnet-

worksandthesourcingofinputstocountriesalliedwiththehome

countryandtrustedpartnersthatsharesimilarvalues.Thechapter

usesthesetermsinrelationtothedecisiontorelocateFDI(rather

thantothemoregeneraldecisionofwheretosourceinputs).

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CHAPTER4GEOECONOMICFRAGMENTATIONANDFOREIGNDIRECTINvEsTMENT

fragmentationthroughtradeandtechnological

decoupling,3existingworkhasnotyetlookeddirectlyatFDIfragmentation.Butthisislikelytobearelevantchannelthroughwhichtheemergenceofgeopolit-

icalblocscouldhaveglobalspillovers.Infact,FDI

accountsforasubstantialshareofdomesticcapital

stockglobally—about12percent,onaverage—andisgenerallyassociatedwithknowledgetransfertodomes-ticfirmsandeconomicgrowth,especiallyinemergingmarketanddevelopingeconomies(Alfaroandothers2004;Javorcik2004;Koseandothers2009).Areloca-tionofFDIclosertosourcecountriescouldhavedirectnegativeeffectsoncurrenthosteconomiesthrough

lowercapitalandtechnologicaldeepening,asfirms

expressinginterestinreshoringandfriend-shoring

tendtobeonaveragelarger,moreprofitable,andmoreknowledge-intensive(Figure4.3).

Againstthisbackdrop,thischapterstartsbylookingforearlysignsofFDIfragmentation,usingdetailed

bilateralinvestment-leveldataonFDIfrom2003

totheendof2022.Itinvestigatestwoquestions:

(1)IsthereanyevidenceofreallocationofFDIacrosscountries,indicatingthatflowsarebecomingmore

fragmented?and(2)DogeopoliticalfactorscontributetoexplainingbilateralFDIflows,sothatcountries

deepentheirintegrationwithfriendsandreduce

theirrelianceonfoes?Thechapterdevelopsamulti-dimensionalindexofcountries’vulnerabilitytoFDIrelocationcombininginformationonthegeopoliticaldistancebetweensourceandhostcountries,shareofstrategicsectorinvestmentintotalFDIinflows,anddegreeofmarketpowerenjoyedbythehostcountry.

Next,thechapterturnstoquantifyingthepotentialcostsofFDIfragmentationandtheirdistributionacrosscountries.TounderstandthechannelsthroughwhichapotentialunwindingofFDIcouldaffecthostcoun-

tries,thechapterempiricallyexaminesFDIspillovers,takingbothmacro-andmicro-levelapproaches.An

extensiveliteratureontheeconomiceffectsofFDIonhostcountriesdoesnotdeliverconsistentresultswhen

simplylookingataggregateflows(Bénétrix,Pallan,andPanizza2022).Thechapterextendsthisliteratureby

conductingacountry-levelanalysisoftherelationshipbetweenGDPgrowthandFDIseparatelyforhorizontal

3See,amongothers,Cerdeiroandothers(2021);Eppingerand

others(2021);Felbermayr,Mahlkow,andSandkamp(2022);

Giammettiandothers(2022);GóesandBekkers(2022);andJavorcikandothers(2022).ArelatedliteraturelooksattheeffectsofBrexitandthe2018–19US-Chinatradewar;seeCaliendoandParro(2021)andFajgelbaumandKhandelwal(2022)foranextensivereview.

Figure4.3.InterestinReshoringandFirmCharacteristics

Firmsmorelikelytoreshorearelargerandmoreproductive.

30

25

20

15

10

5

0

–5

Nomentionofreshoring

Withmentionofreshoring

Numberofemployees

Sales

(dollars,logarithm)

Intangibleassets

(shareoftotal

assets)

Profitability(EBITtoassets)

Sources:Compustat;Hassanandothers(2019);NLAnalytics;andIMFstaffcalculations.

Note:Simpleaveragesacrossfirmsthatmentionedordidnotmentionreshoring,friend-shoring,andnear-shoringinearningscalls.Differencesacrossgroupsarestatisticallysignificant.EBIT=earningsbeforeinterestandtaxes.

andverticalinvestment,asthelatterismorelikelytobeaffectedbygeoeconomicfragmentation.Asubsequentfirm-levelanalysiscombinesinvestment-levelFDIdatawithalargesampleofcross-countryfirm-levelsurveystoidentifypotentialspilloverstofirmlaborproductivitywithinandacrosssectorsalongthevaluechain.

Finally,thechaptercalibratesanumberofillustra-tivehypotheticalscenariostoprovideasenseofthe

possiblelong-termeconomicimplicationsofFDIfrag-mentationusingamultiregiondynamicstochasticgen-eralequilibrium(DSGE)model.Itemploysscenariostoexplorethedistributionofcostsandbenefitsacrosseconomies,includingthosefromspilloversthrough

externaldemandandthereallocationofproduction

capacity.Fragmentationismodeledasapermanentriseininvestmentbarriersbetweenopposinggeopoliticalblocscenteredonthetwolargesteconomies(China

andtheUS),witheconomiespursuinganonalignedpathpotentiallyfacingheighteneduncertainty.

Themainconclusionsfromthechapter

areasfollows:

.TherecentslowdowninFDIhasbeencharacter-

izedbydivergentpatternsacrosshostcountries,

particularlywhenconsideringinvestmentin

strategicsectors,likesemiconductors.FDIflowsareincreasinglyconcentratedamongcountriesthataregeopoliticallyaligned.Theroleofgeopolitical

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WORLDECONOMICOUTLOOK:AROCKyRECOvERy

alignmentindrivingthegeographicfootprintof

FDIisparticularlyrelevantforemergingmarketanddevelopingeconomiesandhasincreasedsince2018,withtheresurgenceoftradetensionsbetweenthe

USandChina.Thus,ifgeopoliticaltensionswere

toincreaseandcountriesweretomovefartherapartalonggeopoliticalfaultlines,FDIislikelytobecomemoreconcentratedwithinblocsofalignedcountries.EffortstopreserveamultilateraldialogueareneededtokeepFDIfragmentationfromincreasing.

.Analysisfromamultidimensionalindexofvulner-abilitytoFDIrelocationsuggeststhat,onaverage,emergingmarketanddevelopingeconomiesare

morevulnerabletosuchrelocationthanadvanced

economies.Thisismostlybecauseofemergingmar-ketanddevelopingeconomies’relianceonFDIfromcountrieswithwhichtheyarerelativelyunaligned

geopolitically.Severallargeemergingmarkets,

acrossdifferentregions,showhighvulnerabilitiestorelocationofFDI,indicatingthatthefragmentationscenarioisnotariskonlyforafewcountries.As

betterregulatoryqualityisassociatedwithlower

vulnerability,countriescouldmitigatetheirexposuretoFDIrelocationbyintroducingpoliciesandregu-lationstopromoteprivatesectordevelopment.

.AfurthercontractioninFDIandashiftinitsgeo-

graphicdistributionwouldlikelyhavelargenegativeeffectsonhostcountries,throughlowercapitalaccu-mulationandtechnologicaldeepening.ThechapterfindsthatverticalFDI,morelikelytobetargetedbypoliciesaimedatfriend-shoringinvestmentinstrate-gicsectors,isassociatedwitheconomicgrowth,notleastbecauseofitsknowledge-intensivenature.Theentryofmultinationalcorporationsalsodirectlybene-fitsdomesticfirms.Inadvancedeconomies,increasedcompetitionfromforeignfirmspushesdomesticfirmstobecomemoreproductive.Inemergingmarketanddevelopingeconomies,domesticsuppliersbenefit

fromtechnologytransfersandincreasedlocaldemandforinputsfromforeignfirmsindownstreamsectors.

.Illustrativemodel-basedscenariossuggestthatFDIfragmentation—modeledasapermanentrisein

cross-blocbarrierstoimportinginvestmentinputs—couldsubstantiallyreduceglobaloutput,byabout2percentinthelongterm.Simulationsofvarioushypotheticalscenariossuggestthatthelossesare

likelytobeunevenlydistributed,withemergingmarketanddevelopingeconomieswithreducedaccesstoadvancedeconomiesparticularlyaffected,throughbothlowercapitalformationandreduced

productivitygains.Whilethediversionofinvest-mentinputscouldallowsomeeconomiestogain,suchbenefitscouldbesignificantlyoffsetbyspill-oversfromlowerexternaldemand.Alternatesce-nariosareusedtohighlightthatnonalignedregionscouldhavesomenegotiatingpowervis-à-visthe

geopoliticalblocs.However,uncertaintyregardingtheiralignmentcouldrestricttheirabilitytoattractinvestment.Theestimatedoutputlosseshighlighttheimportanceofcarefullybalancingthestrategicmotivationsbehindreshoringandfriend-shoringagainsteconomiccoststothecountriesthemselvesandtothirdparties,includingthroughmultilateralconsultationstoreduceuncertaintyforbystanders.

EarlySignsofFDIFragmentation

RecenttrendspointtotheemergenceofFDIfragmen-tation.Thischapterreliesoninvestment-leveldataon

new(greenfield)FDIfromfDiMarkets,whichprovidesdataonabout300,000investmentsfromthefirstquarterof2003tothefourthquarterof2022.Therichness

ofthedata—whichincludeinformationonthesourceandhostcountriesandonthesectorandpurposeoftheinvestment—allowsforzoominginonspecificregions,countrypairs,andindustries.4Italsopermitsclassifica-tionofcertainsectorsas“strategic”:thoseforwhichpoli-cymakersmaybeparticularlyinterestedinrelocationduetonationalandeconomicsecurityinterests.5Throughoutthechapter,thenumberofgreenfieldforeigndirect

investmentsisusedasthemeasureofFDI.6

4Asthedatadonotshowdivestment,thechapterstudiesthe

geographicfootprintofnewdirectinvestments.Onceaggregated

atthehostcountry–yearlevel,theinvestment-leveldataarehighlycorrelatedwithgrossFDIinflows,andthedistributionsofthetwoshowalargedegreeofoverlap,asalsoshownbyToewsandVézina(2022).Asdataonmergersandacquisitionsarenotavailablefromthesamedatasource,theanalysisisbasedexclusivelyongreenfieldinvestments.New(greenfield)investmentsaremorenumerousthanmergersandacquisitions,especiallyinemergingmarketanddevel-opingeconomies;aremorehighlycorrelatedwithaggregatedataonFDI;andarelessfrequentlyconcentratedintaxhavens.TomitigatetheriskthatfindingsareaffectedbyphantomFDI(Damgaard,

Elkjaer,andJohannesen2019),therobustnessoftheanalysisis

testedexcludingFDIfromandtointernationalfinancialcenters.MoredetailsarediscussedinOnlineAnnex4.1.Allonlineannexesareavailableat

/en/Publications/WEO

.

5Thechapterdefinesstrategicsectorsatthethree-digitindustrylevel.MoredetailsarediscussedinOnlineAnnex4.1.

6AsinvestmentvaluesinthefDiMarketsdatasetareoftenestimated,thechapter’smainanalysisreliesonthenumberofinvestments;inthechapter,achangeinFDIreferstoachangeinthenumberofgreenfieldforeigndirectinvestments.OnlineAnnex4.1showsthatthemain

resultsarerobusttotheuseofinvestmentvalues.

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CHAPTER4GEOECONOMICFRAGMENTATIONANDFOREIGNDIRECTINvEsTMENT

Figure4.4.ForeignDirectInvestmentFragmentation

(Numberofinvestments,four-quartermovingaverage,2015:Q1=100)

Foreigndirectinvestmentflowstodifferentregionsarediverging,withChinalosingmarketshare.

UnitedStatesEurope

ChinaAsia(excludingChina)

3001.InStrategicSectors

US-China

250tradewarCOVID-19

Ukrainewar

200

150

100

50

0

17:Q119:Q121:Q122:

2015:

Q1Q4

3002.InSemiconductorIndustry

Ukrainewar

US-China

250tradewarCOVID-19

200

150

100

50

0

17:Q119:Q121:Q122:

2015:

Q4

Q1

Sources:fDiMarkets;andIMFstaffcalculations.

Note:VerticallinesindicatethestartofUS-Chinatradewar,thestartoftheCOVID-19pandemic,andthestartoftheUkrainewar,respectively.

Manyfactorslikelycontributedtotheslowdown

inFDIbeforethepandemic,suchasincreasing

automationandothertechnologicalchanges(Alonsoandothers2022).YetsomerecentpatternspointtoincreasedFDIfragmentationasgeopoliticaltensionsandinward-lookingpolicieshavegainedimportance.TheflowofstrategicFDItoAsiancountriesstarted

todeclinein2019andhasrecoveredonlymildly

inrecentquarters.Bycontrast,flowsofstrategic

investmentstotheUSandEuropehaveprovedmoreresilient.Asaresult,bythefourthquarterof2022,

asignificantgapemergedbetweennewinvestment

directedtotheseregions,withstrategicFDItoEuropeabouttwicethatgoingtoAsiancountries(Figure4.4,panel1).Fragmentation—andspecificallythelackofrecoveryofFDItoChina—isevenmoreapparentfor

Figure4.5.ForeignDirectInvestmentReallocationacross

Regions,2020:Q2–22:Q4versus2015:Q1–20:Q1

(Percentagepointdeviationfromaggregatechange)

Theregionalshiftinforeigndirectinvestmentflowsshowswinnersandlosers.

Sourceregions

Restoftheworld

China

Asiaexcl.

ChinaEmerging EuropeAdvanced EuropeAmericasexcl.US

UnitedStates

26.4

7.1

5.3

11.4

–3.7

–24.7

18.6

–22.1

–6.9

–17.8

–31.3

–44.3

–31.9

–3.2

–8.7

–11.7

–2.4

–23.7

–49.2

–4.4

27.6

2.9

9.9

18.1

–22.3

13.9

–11.5

7.5

–11.7

9.3

–0.9

–9.8

–19.7

8.6

18.6

27.3

14.9

34.0

5.9

–13.3

27.6

9.2

0.6

19.4

2.3

–40.6

21.6

UnitedAmericasAdvancedEmergingStatesexcl.USEuropeEurope

Asiaexcl.China

ChinaRestof theworld

Destinationregions

Sources:fDiMarkets;andIMFstaffcalculations.

Note:Figureshowsdeviationofregionalforeigndirectinvestmentchangefrom

aggregatechange(19.5percentdecline).Changesarecomputedusingthenumberofgreenfieldforeigndirectinvestmentsin2020:Q2–22:Q4andaveragenumberin2015:Q1–20:Q1.Green(red)shadingdenotespositive(negative)numbers.

Excl.=excluding.

foreigninvestmentinR&Dandinspecificstrate-

gicindustries,suchasthesemiconductorindustry

(Figure4.4,panel2),whichboththeUSandthe

EuropeanUnionhavetargetedwithpoliciesdirectedatstrengtheningdomesticproductionandreducingthevulnerabilityfromunalignedforeignsuppliers.

Thesepatternsareindicativeofamoregeneral

processofreallocationofFDIflowsacrosscountries.

FDIdeclinedinthepost-pandemicperiodfromthe

secondquarterof2020tothefourthquarterof2022byalmost20percentcomparedtothepost–globalfinancialcrisispre-pandemicaverage.Butthisdeclinehasbeen

extremelyunevenacrossregions,withtheemergenceofrelativewinnersandlosersasbothsourceandhostofFDI(Figure4.5).Asiabecamelessrelevantbothasasource

andhost,losingmarketsharevis-à-visalmostallother

regions.Notably,FDItoandfromChinadeclinedby

evenmorethantheAsianaverage,althoughthepersistenteffectofthepandemicandprolongedlockdownscouldalsohavecontributedtothefallinforeigninvestment.

Inotherregions,suchastheUSandemergingEurope,greenfieldFDIdeclinedlessand,insomecases,evenincreased(forexample,inflowstoemergingEurope).

InternationalMonetaryFund|April202395

CRI

COL

IND

CAN

KOR

TWN

MYS

SGP

AUS

MEX

BRA

VNM

JPN

ARG

PHL

HKG

CHN

WORLDECONOMICOUTLOOK:AROCKyRECOvERy

Figure4.6.ChangeinOutwardUSForeignDirectInvestment,2020:Q2–22:Q4versus2015:Q1–20:Q1

(Percentagepointdeviationfromaggregatechange)

USforeigndirectinvestmentpartlyshiftedfromlesstomorealignedcountries.

120

80

40

0

–40

Sources:fDiMarkets;andIMFstaffcalculations.

Note:FigureshowsthedeviationofoutwardUSforeigndirectinvestmentchangebydestinationfromaggregatechange(24percentdecline).Changesare

computedusingthenumberofgreenfieldforeigndirectinvestmentsfromthe

UnitedStatestoEuropeandAsiain2020:Q4–22:Q2andaveragenumberin

2015:Q1–20:Q1.Labelsonthex-axisuseInternationalOrganizationfor

Standardization(ISO)countrycodes.“TWN”refersto“TaiwanProvinceofChina.”

Figure4.7.ForeignDirectInvestmentbetween

GeographicallyandGeopoliticallyCloseCountries

(Percent)

Theimportanceofgeopoliticaldistanceforforeigndirectinvestmenthasincreased.

55

GeopoliticaldistanceGeographicaldistance

50

45

40

35

302003060912151821

Sources:Bailey,Strezhnev,andVoeten(2017);Centred’étudesprospectivesetd’informationsinternationales,Gravitydatabase;fDiMarkets;andIMFstaff

calculations.

Note:Figureshowstheannualshareoftotalforeigndirectinvestmentsbetweencountrypairsthataresimilarlydistant(thatis,insamequintileofdistance

distribution),geopoliticallyandgeographically,fromtheUnitedStates.

InregardtooutwardFDIfromtheUS,thebot-

tomrowofFigure4.5showsthatUSFDItoChina

declinedbymuchmorethantheaverageglobaldecline.Atthesametime,USFDItootherregions—and

particularlytoemergingEurope—wasmoreresilient.ThisshiftinthecompositionofoutwardUSFDIcanbeanalyzedindetail,lookingatdifferencesbetween

hosteconomies(Figure4.6).AmongmajorAsianandEuropeanrecipientsofUSFDI,someoftherelativewinners(forexample,Canada,Korea)arepolitically

closertotheUSthantherelativelosers(forexample,China,Vietnam).ThissuggeststhatgeopoliticalfactorshavedrivenpartoftheshiftinFDIflowsinrecent

years.Thenextsectioninvestigatesthisissueindetail.

FDIIsBecomingMoreResponsivetoGeopoliticalFactors

Risinggeopoliticaltensionsareakeydriverof

FDIfragmentation,asbilateralFDIisincreasinglyconcentratedamongcountriesthatsharesimilar

geopoliticalviews(Figure4.7).Thischaptermeasuresgeopoliticalalignmentbetweencountriesusingthe“idealpointdistance”proposedbyBailey,Strezhnev,andVoeten(2017),whichisbasedonthesimilarity

ofvotingpatternsattheUnitedNationsGeneral

Assembly.7Astransportationcostsandgeographic

frictionsalsoinfluenceFDIdecisions(Alfaroand

Chen2018;Ramondo,Rodríguez-Clare,andTintelnot2015),itisinformativetocomparetheirroleswith

thatofgeopoliticalalignment.TheshareofFDI

amongcountriesthataregeopoliticallyalignedislargerthanthesharegoingtocountriesgeographicallyclose,suggestingthatgeopoliticalpreferencesplayakeyroleasadriverofFDI.Inaddition,theimportanceofgeo-politicalalignmenthasincreasedoverthelastdecade,

7Recentanalysisofgeoeconomicfragmentationlooksatrecent

votes,suchastheUNGeneralAssemblyvoteonResolutionES-11/1onaggressionagainstUkraineonMarch2,2022(Chapter3of

theOctober2022RegionalEconomicOutlook:AsiaandPacific;

Javorcikandothers2022).However,thischapterlooksattheroleofgeopoliticalalignmentoveralongerperiod:thelast20years.Inthisrespect,theidealpointdistancehastheadvantageofbeingcompa-rableovertime.Althoughtheidealpointdistanceiswidelyusedinpoliticalscienceandineconomics,scholarshaveproposedalternativemeasures.Thefindingsofthechapterarerobusttotheuseofthe

SscoreusedintheApril2023GlobalFinancialStabilityReportandproposedbySignorinoandRitter(1999),whoassignnumericvaluestovotingbehaviorintheUNGeneralAssemblyandcalculatethe

degreeofdisagreementbetweentwocountriesbycomputingthesumofsquareddifferencesofthesevalues.

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sectors

CHAPTER4GEOECONOMICFRAGMENTATIONANDFOREIGNDIRECTINvEsTMENT

andincreasedmoresteeplythantheimportanceofgeo-graphicdistance,especiallyforFDIinstrategicsectors.

Theroleofgeopoliticalalignmentissignificantand

economicallyrelevant,particularlyforemergingmarketanddevelopingeconomies,inagravitymodelthatcon-trolsforotherpotentialdriversofFDIflows.Inthebase-linespecification,anincreaseintheidealpointdistancefromthefirsttothethirdquartileofitsdistribution

(equivalenttomovingthedistancefromthatbetween

CanadaandJapantothatbetweenCanadaandJordan)isassociatedwithadeclineinFDIbetweencountriesofabout17percent.Thisaverageeffectismuchstronger

whenemergingmarketanddevelopingeconomiesare

eitherasourceorahostcountry.Moreover,since2018,coincidentwithincreasingtradetensionsbetweenChinaandtheUS,geopoliticalfactorshavebecomemorerele-vanttoFDIflows.Finally,theanalysissuggeststhatthesefactorsmattermoreinregardtoinvestmentsinstrategicsectors(Figure4.8).Thus,ifcountriesmovefartherapartalonggeopoliticalfaultlines,FDIislikelytobecome

moreconcentratedwithinblocsofgeopoliticallyalignedcountries.Moreover,fragmentationrisksarenotconfinedtoFDIflows.Zoominginonnon-FDIflowspointsoutasharpincreaseincountries’exposuretofinancialfrag-mentationrisk,whichcouldtriggerasignificantglobalreallocationofcapitalinresponsetoariseingeopoliticaltensions(Box4.2).Suchtensionsmattersignificantly

forcross-borderportfolioallocationandcouldcauseasuddenreversalofcross-bordercapitalflows,especiallyinemergingmarketanddevelopingeconomies(seetheApril2023GlobalFinancialStabilityReport).

ThefindingsreportedinFigure4.8arebasedonagravitymodelthattakesbilateralFDIasthedepen-

dentvariableandcontrolsforstandardpush-and-pullfactors,includingasetoftime-varyingfixedeffectsforsourceandhostcountries(KoxandRojas-Romagosa2020).8Tominimizethepossibilitythatthecoefficient

8Theanalysisisbasedonestimatingthefollowingspecification:

=f(αIPDsdt−1+βGravitysd+τst+υdt,εsdt),wherebilateralFDIflows(measuredbythenumberofinvestments)