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Everyone loves a factory opening. Politicians cut ribbons, newspapers tally the new jobs and a country feels it is getting somewhere. Such scenes for many decades have been the classic payoff from foreign direct investment (FDI), the long-term capital that builds things and trains workers, as well as plugging economies into global supply chains. But imagine a different scene: a call-centre or a software hub. These too are fruits of FDI, and they are increasingly the only ones on offer. The money is still welcome, but the kind of development it buys is changing. That is a problem for many poor countries.
True, foreign investment brings cash, but it also packs in technology, management savvy and links to rich-world markets. Study after study confirms its power. A typical emerging economy can expect a decent bump in GDP from a surge in FDI. In places with solid institutions and open trade, the boost is even bigger. For nations short of domestic savings, foreign capital is a pillar of growth.
Also read: Foreign direct investment in poor countries is drying up just when it is needed most
Lately, however, that pillar has been crumbling. Across the emerging world, inflows of FDI have sunk from about 5% of GDP in 2008 to a little over 2% today. The drop is widespread, affecting some three-fifths of developing countries. The very poorest are almost entirely left out, scraping up less than 1% of the global total. This is not just a business-cycle blip. It reflects a chillier and more fractured world economy, where firms think twice before venturing abroad.
As if that were not worrying enough, the character of the investment is changing, too. The old image of a multinational building a plant is fading. Most FDI in the developing world still involves new projects, but now nearly two-thirds of it goes into services such as banking, IT, business support and so on. That fits with the rich world’s “servitisation”, and the jobs are better than toiling on a farm. Yet the economic spillovers are slimmer. A foreign bank may run a tight ship, but it does not nurture local suppliers or import complex industrial know-how. The development engine is being retuned and it may deliver less power.
Not all FDI is created equal. The best sort involves high-tech manufacturing, which drags up productivity, creates skilled jobs and sparks investment elsewhere in the economy. The record for services is patchy: sometimes it contributes little to overall growth, especially when it is just a foreign firm taking over a local business. FDI in mining or farming tends to have barely any positive effect at all. It digs stuff out of the ground, but does little to build up the rest of the country.
This pecking order makes the geography of today’s investment particularly galling. FDI is hyper-concentrated in a few big, relatively advanced emerging markets. Between 2012 and 2023, for example, China alone sucked in about a third of all flows to the developing world. Smaller, poorer countries, which desperately need the jolt that industrial FDI can provide, are left fighting for scraps—often just basic resource projects that do little to transform their economies. The danger is a two-tier developing world, where a handful of countries climb the value chain and the rest are stuck providing raw materials or answering customer-service calls.
Is there any hope? Perhaps in the energy transition. Green investment is leaping, and foreign firms can bring cleaner technologies. There is even a “pollution halo”, whereby they adopt higher environmental standards than local companies. This could help fill the huge funding gap for climate projects. But the old rules still apply: the benefits are biggest in countries with decent institutions and skilled workers. And in many poor places, climate-sensitive sectors are so tangled in red tape that they scare off the very investment they need.
What is to be done? The first task is the unglamorous but essential work of making a country investable: sound macroeconomics, competent institutions, educated workers and open trade. Do that and more capital will come. The second task is trickier: steering investment towards the most productive kinds. That means moving beyond “open for business” billboards to target greenfield projects in high-impact sectors, like advanced manufacturing or renewable energy. It also means using investment-promotion agencies as shrewd scouts not glad-handers, and designing incentives to shape the economy, not only to lure any firm that comes knocking.
Foreign capital is a powerful tool for development. But the patient capital is getting impatient, and ever more choosy. Poor countries cannot afford to wait for it to return on its own terms. They need to build, and fight, for the future they want. It is the hardest kind of work but there is no alternative. ■
