The current decade could mark a turning point in the international division of labour. The coronavirus pandemic and Russia’s attack on Ukraine caused severe disruptions to international supply chains. Production relationships could undergo lasting change owing to the two events, the Bundesbank’s economists write in the October Monthly Report. In their article, they explore whether this is already being reflected in Germany’s foreign direct investment (FDI) relationships.

Growth in FDI especially strong in the United States

As in the past decade, German firms have been investing heavily abroad since the beginning of the 2020s. Specifically, German FDI rose cumulatively by just shy of €1,700 billion between January 2010 and June 2024.

Since 2022, overall FDI dynamics have weakened slightly in line with a global decline in cross-border FDI flows. Measured in terms of stock data, the United States and the euro area are the most important sites for German FDI in manufacturing, the economists report. At the end of 2022, the two economic regions collectively accounted for more than half of German equity capital held in manufacturing via FDI.”

According to the economists, the 2020 to 2022 period saw stocks of German FDI in energy-intensive economic sectors in the United States rise particularly sharply. Energy-intensive economic sectors include the manufacture of chemicals and chemical products and the manufacture of basic metals. In connection with the slump in industrial production in Germany, this could indicate that energy-intensive enterprises are availing themselves of foreign production sites owing to relatively inexpensive production costs, amongst other factors, they explained.

Higher level of FDI overall, but at the same time lower new FDI in China

The importance of China and other G20 emerging economies as destinations of German FDI in manufacturing grew in the 2020 to 2022 period at an accelerated pace relative to the preceding years. In 2022, German FDI equity capital grew both in China (from €62 billion to €79 billion) and in the rest of the G20 emerging economies (from €53 billion to €61 billion). German firms’ heavy investment in China was attributable largely to reinvested earnings in the past years and the first half of 2024, the authors write. They note that this sets German enterprises apart from other foreign groups, the majority of which withdrew retained earnings from previous years, thereby reducing their equity interests in China.

According to the authors, German firms have tended to be cautious regarding new FDI in China, whereas they have begun to invest more again in the United States. Two reasons for this may be that economic growth in China has cooled off and that the US administration has set strong incentives for locating production in the United States. The fact that there are fewer Chinese subsidiaries since 2017 is an indication that China may have lost some of its attractiveness as a destination for greenfield investment by German enterprises, they report.

Lower FDI inflows to Germany since 2022

The article in the October Monthly Report also explores whether reduced inward flows of FDI into Germany could be a sign that Germany is becoming internationally less competitive as a business location.

From end-2019 to June 2024, foreign investors increased their equity capital in Germany by a cumulative €163 billion, the economists write. The majority of this investment was from non-euro area countries. The most important originator country was the United States, at €56 billion, followed by the Netherlands (€35 billion) and the United Kingdom (€17 billion).

The authors report that inward FDI in Germany has declined significantly since 2022, remarking that since the end of 2021, the rest of the euro area has made available next to no additional equity capital, on balance. Inflows from third countries, though still positive, have tailed off markedly relative to the period between the end of 2019 and the end of 2021.

Following investments by foreign enterprises collectively amounting to just over €100 billion in equity capital in Germany in the years 2020 and 2021, Germany subsequently received only €62 billion in equity capital up until mid-2024.

It is indeed possible to identify a statistically significant structural break in 2022, which led to a significant reduction in the amount of FDI received by Germany, the economists write. In addition, inflows of funds from the United Kingdom have diminished markedly in importance since Brexit.

France and Spain popular among FDI donors

The economists determined that, compared with other industrial nations, France and Spain have recently been more successful in attracting FDI. One reason for the reduction in FDI inflows to Germany since 2022 could be high energy prices in the country. In the authors’ view, Germany and Europe will have to show amid the stiff competition between locations for foreign investment that they can maintain their international competitiveness and ability to attract foreign capital.