Trade Restrictions, Trade Policy Uncertainty and FDI Flows

Hites Ahir, Luca Bettarelli, Davide Furceri, Francesco Frangiamore, Jonathan D. Ostry and Francesco Scianna

No 21524, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Using bilateral foreign direct investment (FDI) flows data for a panel of 35 host and 243 source countries over 1985–2023 and dynamic gravity-based local projections, we show that trade restrictions and trade policy uncertainty in host countries generate economically significant and persistent declines in bilateral FDI inflows. These effects vary systematically across source- and host-country characteristics. FDI from low- and middle-income countries responds more strongly, consistent with tighter financial constraints. On the host side, adverse effects are mitigated under countercyclical fiscal policy and stable exchange rates but are amplified under greater capital account openness. Bilateral factors also shape transmission: stronger global value chain (GVC) integration amplifies the impact of trade restrictions and uncertainty shocks, while greater geopolitical distance strengthens the effects of trade restrictions but reduces the sensitivity of FDI to trade policy uncertainty, as baseline risk is already higher in more distant relationships. Finally, trade shocks not only reduce average FDI but also increase its uncertainty, raising downside risks. These results are robust across a range of specifications, including instrumental variable and difference-in-differences approaches.

Keywords: Foreign direct investment; Trade policy restrictions; Uncertainty; Local projections; Location-scale approach (search for similar items in EconPapers)
JEL-codes: F13 F21 G15 (search for similar items in EconPapers)
Date: 2026-05
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