Economics & Development

Despite heightened interest in the role of geopolitics and fragmentation for cross-border economic activity, there is limited understanding of the potential scarring effects of adverse global conditions on foreign direct investment (FDI). Accounting for the real-time nature of investor decisions, local projection estimates show that adverse global growth shocks have scarring effects on FDI project announcements for about three years. Beyond the baseline finding, the paper offers three novel results: scarring effects are more subdued in “safe” countries; projects in “strategic” sectors smooth headline announcement fluctuations because they are less sensitive to adverse global growth shocks; and geopolitical positioning plays an important role in the uneven recovery of FDI announcements. The results are robust to a variety of additional exercises, including sample adjustments, alternative shock measures and specifications, and various definitions of institutions, sectors, and geopolitical alignment.