Flows of foreign direct investment (FDI) into developing economies have dwindled to the lowest level since 2005 amid rising trade and investment barriers, new research from the World Bank has shown.

FDI is a key propellant of economic growth and higher living standards. However, these barriers are posing a significant threat to global efforts to mobilise financing for development, the World Bank said on June 16.

In 2023, the latest year for which data is available, developing economies received just $435-billion in FDI, the lowest level since 2005.

This coincides with a global trend in which FDI flows into advanced economies have also slowed to a trickle. High-income economies received just $336-billion in 2023, the lowest level since 1996.

As a share of their GDP, FDI inflows to developing economies in 2023 were just 2.3%, about half the number during the peak year of 2008. 

“What we’re seeing is a result of public policy. It’s not a coincidence that FDI is plumbing new lows at the same time that public debt is reaching record highs. Private investment will now have to power economic growth and FDI happens to be one of the most productive forms of private investment.

“Yet, in recent years, governments have been busy erecting barriers to investment and trade when they should be deliberately taking them down. They will have to ditch that bad habit,” World Bank chief economist and senior VP Indermit Gill said.

From June 30 to July 3, representatives of governments, international institutions, civil society organisations and the private sector are scheduled to meet in Seville, Spain, to discuss how to mobilise the financing that will be needed to achieve key global and national development goals. 

The new analysis from the World Bank highlights the policies that will be needed to achieve those goals at a time when economic growth has slowed to a crawl, public debt has surged to record highs and foreign-aid budgets have shrunk.

Easing investment restrictions will be a key first step. So far this year, half of all FDI-related measures announced by governments in developing economies have been restrictive measures, which is the highest share since 2010, the World Bank said.

“With the global community gearing up for the Conference on Financing for Development, the sharp drop in FDI to developing economies should sound alarm bells. Reversing this slowdown is not just an economic imperative.

“It’s essential for job creation, sustained growth, and achieving broader development goals. It will require bold domestic reforms to improve the business climate and decisive global cooperation to revive cross-border investment,” World Bank deputy chief economist and Prospects Group director M Ayhan Kose said.

Investment treaties tend to boost FDI flows between signatory States by more than 40%, the World Bank analysis found. Between 2010 and 2024, just 380 new investment treaties came into force, barely a third of the 1990s number.

Similarly, the report found that countries that are more open to trade tended to receive more FDI at a rate of an extra 0.6% in FDI for each percentage-point increase in the trade-to-GDP ratio.

However, the number of new trade agreements signed over the past decade dropped nearly in half, from an average of 11 a year in the 2010s to just six a year in the 2020s.  

In 2023, FDI accounted for about half of the external financing flows received by developing economies. The World Bank said that, under the right conditions, it is a strong spur to economic growth.

An analysis of data from 74 developing economies between 1995 and 2019 suggested that a 10% increase in FDI inflows generates a 0.3% increase in real GDP after three years. The impact is nearly three times larger – up to 0.8% – in countries with stronger institutions, better human capital, greater openness to trade, and lower informality.

By the same token, the effect of FDI increases is much smaller in countries that lack such features. 

The World Bank noted that FDI tended to be concentrated in the largest economies. Between 2012 and 2023, about two-thirds of FDI flows to developing economies went to just ten countries, with China receiving nearly a third of the total and Brazil and India receiving about 10% and 6% respectively. The 26 poorest countries received barely 2% of the total.

Meanwhile, advanced economies accounted for nearly 90% of the total FDI in developing economies over the past decade. About half of that came from just two sources: the EU and the US. 

The report identifies three policy priorities for developing economies.

First is the need to double efforts to attract FDI.

Easing FDI restrictions that have accumulated over the last decade would be a good start, along with speeding up improvements in the investment climate, which have stalled in many countries over the past decade, the World Bank said.

Strong macroeconomic outcomes, such as healthy growth and rising labour productivity, also help accelerate FDI flows, the analysis showed.

An increase of 1% in a country’s labour productivity, for example, is associated with an increase of 0.7% in FDI inflows. 

Secondly, it suggests amplifying the economic benefits of FDI.

Promoting trade integration, improving the quality of institutions, fostering human capital development and encouraging more people to participate in the formal economy would increase the benefits of FDI, the World Bank said.

Governments could also amplify the benefits by channelling FDI to sectors where the impact is the greatest. FDI could also help increase job opportunities for women, as the domestic affiliates of multinational enterprises, for example, tended to have a greater share of female employees than domestic firms. 

Lastly, it emphasises the need to advance global cooperation.

The World Bank suggested that all countries should work together to accelerate policy initiatives that can help direct FDI flows to developing economies with the largest investment gaps.

Especially in a time of high geopolitical tensions, the World Bank and other international institutions have a crucial role to play in supporting a rules-based order.

Technical and financial assistance to support structural reform efforts in developing countries, especially low-income countries, are critical for facilitating FDI inflows.