by Joseph Joyce
The Rise and Fall of FDI
After the global financial crisis, international capital flows contracted, especially bank lending in Europe. Foreign direct investment (FDI) by multinational firms, however, provided a steady source of external finance, particularly for emerging market economies. The McKinsey Global Institute has calculated that the global stock of FDI increased from 46% of world GDP in 2007 to 57% in 2016 ($25 trillion to $41 trillion). But FDI flows fell by 27% in 2018 according to the Organization of Economic Cooperation and Development (OECD), and this drop followed a decline of 16% in the previous year. We have entered a new period of contraction by multinational firms, and in particular, U.S.-based multinationals.
A significant amount of the decline is due to firms based in the U.S. responding to changes in U.S. tax law. The U.S.-based firms repatriated earnings that had been kept abroad to avoid U.S. taxes. As a result, the U.S. recorded a negative FDI outflow of $50 trillion in 2018, down from a positive outflow of $379 billion in the previous year. By the latter half 2018, the acquisition of foreign assets had returned to positive levels, but the long-run changes of the tax code revision on the foreign operations of U.S. firms will only become clear over time.
Ireland and Switzerland were particularly hard-hit by the disinvestments, since these countries had often attracted FDI because of generous tax provisions. There were also reversals of investment in Special Purpose Entities (SPE), which allow the multinationals to channel funds through countries with favorable regulatory and tax practices to their ultimate destination. The OECD reported that FDI flows to SPEs in Luxembourg and the Netherlands fell to negative levels last year.