The pandemic and the war in Ukraine have accelerated the restructuring of global value chains (GVCs). Once driven by the pursuit of efficiency, multinational corporations have been reassessing their global footprint to adjust to the new, fractious geopolitical climate. “It’s costly, but they have to do it,” James Zhan, director of investment and enterprise at Unctad, tells fDi. 

Q: What is your current outlook on global investment? 

A: Global foreign direct investment (FDI) experienced a strong recovery in 2021, but the prospects turned gloomy for 2022. There are three sets of indicators that point in that direction.

A first set relates to the multiple crises the world economy is facing — what I refer to as the three F’s and double H’s: the food, fuel and financial crisis combined with the humanitarian crisis in eastern Europe and parts of Africa, as well as the health crisis caused by the pandemic that is not over yet.

The second set of indicators concerns macroeconomic indicators — the three highs and three lows. High levels of debt and inflation, as well as higher interest rates; low growth of gross domestic product, trade and gross fixed capital formation. 

A final set of indicators relates to our preliminary data for the first quarter of the year, with decreasing numbers of greenfield FDI projects and deals of project finance. More importantly, according to our survey of the largest 5000 multinational corporations in the world, earning forecasts have in most cases been revised downward.

These are the three main sets of indicators that tell us global investment flows are on a downward trajectory with increasingly high levels of risk. In the best-case scenario, global investment flows will flatten out. In the worst case, they will be nosediving towards 2020 levels. Having said that, there are opportunities that lie in investment in green and blue economies, in renewables infrastructure; there are still projects in the pipeline driven by the stimulus packages of last year, and also services offering — high value-added services in particular will create opportunities for firms and for countries to attract international investment in the years to come.

Q: Do you think that this is the dawn of a new era defined by a multipolar order, shaped around the big centres of power like the US, China and Europe? 

A: There are two levels to consider here: a firm-level international production system organised in GVCs and a policy level. With regards to GVCs, globalisation accelerated between 1990s and 2010, and we have seen a drastic increase in GVC growth; between 2010 and 2020 globalisation stagnated, and since the pandemic we have seen globalisation reversing — some refer to this last twist as deglobalisation.

There are five main driving forces behind it: economic governance realignment, which is clearly driven by geopolitical rivalry and industrial nationalism; the push towards technological sovereignty and the role that the new industrial revolution plays in shaping the future of GVCs; the sustainability imperative; ESG principles that will also change the behaviour of companies and the way GVCs are managed; and the resilience-driven type of restructuring of GVCs. These forces are transforming GVCs through reshoring, diversification, regionalisation and replication. All this will lead to new patterns of global trade and investment, that is the decline of efficiency-seeking FDI and the increase of regional market-seeking FDI. With regards to the policy level, the perspective is different.

Unlike the WTO for trade or the IMF for the monetary system, there is no global governance in investment. Global investment governance has always been multi-layered, multi-faceted and highly fragmented. Between 1990 and 2010, there was a proliferation of bilateral investment treaties and treaties at a sub-regional level. And later on, for the past decade, there was a kind of acceleration of treaty making and rulemaking at regional and mega-regional level. In essence, the governance of global investment was not globalised at all. 

Q: Many companies are facing the trade-off between chasing efficiency and falling in line with top-down policies pushing for the reshoring or nearshoring of strategic value chains like semiconductors and electric vehicle (EV) batteries. What’s your assessment of these developments?  

A: It’s costly, but they have to do it. It is costly because diversification means redundancy; relocation involves a lot of costs, but they have to do it because of the current geopolitical risks that have been increasing so much. Companies are prepared to do it, they are doing it in a gradual manner; they also try to wait and try to minimise the cost and the risks while doing so.

We have seen this happening. In fact, my personal observation is that in Asia, which has become the world’s manufacturing hub, we have seen diversification from east Asia into south-east Asia and South Asia, specifically to India and some Asean countries. That’s been partly driven by some government support and partly driven by decisions from the same firms due to the trade war. This kind of barrier-hopping FDI has been happening. Beyond Asia, the Ukraine war has destabilised the sub-region there.

That could reverse the west-to-east pattern of investment of the past few decades, with investment flowing back from east to west. With regard to North America, we have seen the kind of efforts by the US administration to bring back industrial clusters, particularly in Central America and the Caribbean, including Mexico. So, this is happening, and it’s back to the future, so to speak, because at the beginning of the 1980s we had the triad made up by US-centric North America, Europe and then Japan-centric Asia. Now we see the emergence of similar patterns, we are getting back to multiple sub clusters. 

Q: What do you think about the proposals of a global minimum corporate tax rate? How is this going to affect foreign investment flows? 

A: The global tax reform, particularly the global minimum corporate income tax reform, is commendable. It is a global effort that goes in the direction of mobilising domestic resources. It is one of the sustainable development goals that has been endorsed by leaders worldwide. In the meantime, it will help stop the ‘race to the bottom’ — this tax competition is a lose–lose situation.

The reform ultimately creates a stable investment environment. This is from a tax, domestic resource mobilisation perspective. On the other hand, from an investment perspective, it creates challenges. We have done analysis on this, and we have seen that the global corporate minimum corporate income tax reform will impact investment flows and patterns of investment.

There are investment volumes implications, but also investment diversion implications. Statutory corporate income taxes fell, on average, from 40% in the 1980s to about 25% today. After considering the various kinds of incentives and the ways corporate income taxes are levied, the global average effective tax rate is less than 20%. In our research, we have gone even further and analysed the issue at an FDI level, and found that the average effective rate is below 15%. Its impact on investment flows could be only a 2% downward pressure at global level, which is not much if we consider that global FDI flows are lumpier and more volatile.

But the impact has more to do with diversion. Some advanced developing countries and advanced countries have higher levels of corporate income tax, as well as sound FDI determinants; they may benefit from this investment diversion and tax reforms. For the traditionally low tax jurisdictions, particularly offshore financial centres, investment flows will be significantly reduced. For low-income countries there could be an increase of investment as traditionally their tax rate is traditionally higher.

This will have implications beyond investment policies. Many countries have been using fiscal incentives to upgrade certain sectors and industries, and for attracting investment into some regions to address regional disparities. So, there will be a kind of adjustment required on investment policies and investment promotion strategies, as well as on industrial policies. But this is not for all incentives — the main impact will be on tax holidays — that is below 15%. But for other fiscal incentives, they won’t be impacted. That relates to tax deferrals, tax credits and the deductions related to accelerated depreciation, capital allowances and deduction for special expenses. In essence,  it is rather the profit-based incentives that will be impacted, while it’s less so on expenditure-based incentives.

This article first appeared in the August/September 2022 print edition of fDi Intelligence.