Geopolitical fragmentation and friendshoring evidence from project-level foreign investments data

Abstract

This paper examines the relationship between geopolitical distance and foreign investments over time, countries, and sectors. The analysis uses comprehensive data on foreign direct investments covering greenfield projects, mergers and acquisitions, and stocks of affiliates, as well as data on four alternative measures of geopolitical distance between countries. Our gravity estimations suggest that, first, geopolitical distance has a negative effect on foreign investments and the magnitude has heightened in the post-pandemic period compared to a decade ago, in line with friendshoring forces being at play. Second, it is primarily the companies from advanced Western economies whose foreign investment decisions are increasingly shaped by friendshoring forces. Finally, the paper shows that friendshoring is not only confined to strategic industries, implying that it may not solely reflect national security or resilience considerations.