Writing in a CESifo Working Paper researchers tackle the question ‘Do tariffs encourage/discourage Foreign Direct Investment (FDI)?’.
They discover a range of answers depending on the specific conditions.
The situation in the real world is complicated, as we’ve just learned via the tariffs set by the Trump administration in the U.S. There initial tariff rates have in many cases been modified down. Retaliatory tariffs have been imposed making the bilateral impact harder to parse and finally promised FDI by certain trade partners “Japan $550 billion, Korea $350 billion, EU $750 billion,..” add a further dimension of complexity for effect study.
For the U.S. the lesson from recent history is that FDI has been strong in recent years and seems to be positively associated with a growing trade deficit. The mechanism for this is returns on investment which, where there is a trade deficit, remain relatively high. A reduction of the deficit and therefore investment returns would therefore be expected to reduce FDI.
The paper meanders to a close noting “Historically free trade created deficit[s] but return to capital in USA was higher and attracted FDI. Thus, tariff escalation might go either way, without having much to do with controlling trade surplus or deficit.”
Or, in plain English, the U.S. was doing fine before tariffs were introduced but if tariffs end up raising costs and lowering returns to capital then a fall in FDI will surely occur. Not what the incumbents of the White House would like to see methinks?
You can review the paper in full via this link Tariffs and Capital Flows.
Happy Sunday.