How policy uncertainty redefines global capital flows

The research identifies a “push effect” that occurs when home countries experience greater policy uncertainty than China. In such cases, foreign firms redirect investment into China as a safer destination. The analysis shows that this effect is statistically significant, with a measurable increase in FDI when investors perceive China as more stable than their home economies.

Foreign direct investment (FDI) remains one of the most significant drivers of China’s economic growth, but new research highlights that its trajectory is shaped less by market fundamentals and more by the unpredictability of government policies. A study published in Economies has revealed that economic policy uncertainty (EPU) in both home and host countries exerts dual, and sometimes opposing, effects on investment inflows.

The study “Economic Policy Uncertainty and Foreign Direct Investment: A Bilateral Perspective on Push and Consistency Effects” analyzes panel data from 20 countries between 2005 and 2023 to uncover how cross-border political and institutional stability dictates investment trends. By employing fixed effects and generalized method of moments models, the authors provide one of the clearest pictures yet of how uncertainty drives or deters international capital flows into China.

Does policy instability push investment toward China?

The research identifies a “push effect” that occurs when home countries experience greater policy uncertainty than China. In such cases, foreign firms redirect investment into China as a safer destination. The analysis shows that this effect is statistically significant, with a measurable increase in FDI when investors perceive China as more stable than their home economies.

This phenomenon underscores China’s role as a relative safe haven during periods of turbulence abroad. For example, when advanced economies grapple with shifting fiscal agendas or political gridlock, multinational corporations may seek refuge in China’s comparatively predictable environment. The effect aligns with broader global patterns where capital often flows toward jurisdictions perceived as offering greater stability, even when those markets carry other risks.

However, the push effect is only part of the story. The study emphasizes that while instability abroad can drive capital into China, this mechanism is weaker than the forces working in the opposite direction.

How do policy differences deter foreign direct investment?

The stronger influence uncovered by the research is the “consistency effect.” When there is a wide gap between the policy environment of China and that of home countries, FDI inflows decline significantly. This is because investors face greater transaction costs and risks when navigating two starkly different regulatory landscapes.

The authors found that large disparities in policy frameworks create frictions that outweigh the benefits of relative stability. For example, if China maintains strict regulatory controls while partner countries pursue liberalized investment regimes, the mismatch complicates corporate decision-making and discourages long-term commitments. The consistency effect exerts a larger drag on inflows than the push effect stimulates, showing that policy alignment across borders is more critical than isolated episodes of stability.

Institutional quality further complicates this picture. When China demonstrates strong institutional frameworks, it amplifies the safe-haven appeal. But if uncertainty is already high in both home and host nations, stronger institutions can accentuate the negative consequences by making differences even more visible. This paradox highlights the complexity of policy alignment in the global investment landscape.

What role do politics and comparative stability play?

The study highlights the influence of bilateral political relations. When China maintains cooperative ties with partner governments, the push effect strengthens, and FDI inflows are more likely. However, these same political connections can sometimes backfire in the private sector, where close government-to-government relations may translate into intrusive oversight or market distortions. In such cases, private investors may hesitate despite strong diplomatic ties.

Heterogeneity in China’s own policy environment also matters. When China experiences higher levels of economic policy uncertainty than its partners, foreign investment inflows decline sharply. The research shows that comparative stability is decisive. Even when China’s domestic policies are relatively steady, it is the contrast with foreign partners’ policy environments that determines outcomes. The broader implication is that FDI is not just about absolute levels of stability but about relative perceptions of risk across borders.

These findings suggest that China cannot rely solely on its internal stability to attract capital. Instead, it must consider how its policies align with global norms and the expectations of its largest investors. Similarly, partner countries must recognize that domestic instability has a dual effect: it disrupts their economies while simultaneously channeling capital outward.

Policy lessons for China and its partners

For China, maintaining stability is necessary but insufficient. The greater challenge lies in aligning policies with major investment partners to minimize the negative consistency effect. This may involve harmonizing investment rules, reducing regulatory discrepancies, and ensuring that institutional frameworks are transparent and predictable.

For home countries, the findings serve as a warning that policy volatility not only weakens domestic investment but also accelerates outward capital flight. Governments that allow uncertainty to persist risk fueling investment flows into more stable destinations, often to their own detriment.

At the global level, the study points to the need for improved policy coordination. Multilateral frameworks that promote consistency in investment governance could reduce frictions and strengthen cross-border flows. By focusing on comparative stability and reducing gaps between policy regimes, nations can create a more predictable investment climate.