Geopolitical Shocks Are Reshaping Cross-Border Investment, With Developing Economies Hit Harder

Foreign direct investment is increasingly being shaped by more than market size, costs or access to consumers. As geopolitical tensions fracture trade and investment relationships, multinational firms are paying closer attention to how political risk in one country compares with conditions elsewhere, turning relative stability into a competitive asset for economies seeking long-term capital.

A new study "Relative Geopolitical Positioning and Foreign Direct Investment: Evidence from Cross-Border Capital Allocation", published in the Journal of Risk and Financial Management by Huy Trung Bui and Huong Giang Mai of the Banking Academy of Vietnam, examines this shift. Using bilateral investment data from 36 major investing countries over 2002–2022, the study finds that higher geopolitical risk in source economies relative to Vietnam is consistently associated with lower FDI inflows into the country.

The findings suggest that investment decisions in a fragmented global economy are increasingly relational: firms compare geopolitical environments rather than assessing countries independently. Political stability can weaken the negative association, while severe geopolitical shocks appear to depress investment beyond the immediate period, with developing-country investors significantly more sensitive than their developed-economy counterparts.

Investors Are Comparing Geopolitical Risk, Not Just Measuring It

Most conventional assessments of geopolitical risk focus on the level of uncertainty within an individual country. The study argues that this misses an important feature of foreign investment decisions: multinational companies allocate capital comparatively, weighing one location against another rather than evaluating risk in isolation.

To capture this logic, the researchers construct a geopolitical-risk differential between each investing country and Vietnam. A positive value means the source country faces greater geopolitical risk than Vietnam; a negative value indicates the reverse. The measure is not intended to replace conventional risk indicators, but to add a source–host perspective to the analysis of investment allocation.

The baseline results support that approach. Across several fixed-effects specifications, the coefficient on relative geopolitical risk remains negative and statistically significant, ranging from -0.249 to -0.404. In the specification accounting for both annual shocks and cross-country dependence, the estimate remains significant at -0.249.

In practical terms, higher geopolitical risk in an investing country relative to Vietnam is associated with weaker bilateral FDI flows. The study links this pattern to the long-term and partially irreversible nature of foreign direct investment: when uncertainty increases, companies may postpone projects, scale back expansion or preserve the option to wait.

Supply chains are being reorganised around economic security, political relationships and exposure to sanctions or trade restrictions. Under those conditions, a country's investment attractiveness may improve not only because its own fundamentals strengthen, but because alternatives become more uncertain.

Vietnam illustrates this dynamic particularly well. The country is deeply integrated into international production networks and receives investment from economies with widely differing geopolitical exposures. It has also been described in the wider policy debate as a potential "connector economy" capable of maintaining commercial relationships across geopolitical blocs.

Political Stability Can Reduce the Investment Penalty, but It Is Not a Cure-All

According to the study, the relationship between geopolitical risk and FDI changes with political stability. When investing countries are more politically stable relative to Vietnam, the negative association between geopolitical risk and their investment into Vietnam becomes weaker.

The interaction between geopolitical risk and political stability is positive and statistically significant. At relatively low levels of political stability, the marginal association between geopolitical risk and FDI is strongly negative. At the median, the effect weakens, and at higher levels of political stability it becomes statistically indistinguishable from zero, suggesting that political stability may provide firms with a more predictable institutional base from which to make international commitments. Companies operating in stable environments may have better access to finance, stronger expectations of policy continuity and greater capacity to absorb geopolitical disruptions without immediately cancelling or delaying overseas

However, the moderation analysis does not prove that political stability causally shields FDI from geopolitical shocks, and the buffering effect is not uniformly statistically significant across the full distribution of political stability. The evidence instead indicates that the strength of the geopolitical risk–FDI relationship varies systematically with institutional conditions.

Political stability cannot eliminate geopolitical risk originating elsewhere, but institutional credibility can make investment relationships less fragile. For host countries such as Vietnam, maintaining regulatory consistency, transparent communication and predictable policy may therefore become more valuable as external uncertainty increases.

The broader takeaway for developing economies is that geopolitical competition may place a premium on institutional reliability. Countries unable to influence global rivalries can still influence how investors perceive the stability and predictability of the domestic investment environment.

Geopolitical Shocks Do Not End When the Headlines Fade

The research also challenges the idea that geopolitical disturbances matter only when they occur. Foreign direct investment decisions often involve years of planning, internal approvals, financing arrangements and supply-chain commitments, meaning the response to a geopolitical shock can continue well after the original event.

The study finds that lagged relative geopolitical risk remains negatively and significantly associated with FDI in the following period. The estimated lagged coefficient is -0.363, indicating that higher risk continues to correspond with weaker subsequent investment rather than producing only an immediate reaction.

Large shocks show a similar pattern. The continuous shock measure is negatively associated with FDI, while disturbances above both the 75th and 90th percentiles of the study's shock distribution are linked to lower investment. The estimate is larger for the more extreme threshold, suggesting that severe geopolitical disruption may produce a stronger investment response.

This has practical consequences for governments and investment-promotion agencies. Geopolitical risk monitoring cannot be limited to identifying crises as they unfold. Authorities may also need to track how major events are changing corporate financing capacity, investment approvals and strategic planning in important source countries months or years later.

The finding also helps explain why capital relocation is rarely instantaneous. A geopolitical shock can create incentives for firms to diversify supply chains, but the same event can simultaneously weaken the capacity of companies in affected source economies to fund new overseas projects. The result is not necessarily a simple movement of investment from risky places to safer ones.

For investors, the study reinforces the importance of scenario planning. Geopolitical shocks can alter not only expected returns but the timing of investment, financing conditions and the viability of cross-border production strategies.

Developing-Country Investors Are Far More Exposed to the Geopolitical Squeeze

Perhaps the most notable result emerges when the researchers separate developed and developing source economies. Relative geopolitical risk is negatively associated with FDI from both groups, but the magnitude is substantially larger among developing-country investors.

The estimated coefficient is -0.344 for developed economies compared with -1.323 for developing economies. A pooled interaction analysis confirms that the difference between the groups is statistically significant, supporting the conclusion that FDI from developing-country sources is considerably more sensitive to geopolitical risk.

The authors suggest several possible explanations. Firms from advanced economies may have more diversified international operations, deeper access to capital markets and more sophisticated risk-management capacity. Companies from developing economies may face tighter financing constraints and greater exposure to domestic and external volatility, leaving less room to absorb geopolitical shocks.

The disparity has major implications for South–South investment. As developing economies increasingly invest in one another, geopolitical instability could reduce cross-border capital flows precisely among countries that rely heavily on FDI for industrial development, infrastructure and integration into global value chains.

For host countries, this means investment diversification cannot be judged solely by the number of source markets. The resilience of those source economies matters too. Building a broad investment base that includes firms with different financial capacities and geopolitical exposures may help reduce vulnerability to external shocks.

The study's robustness checks strengthen confidence in the overall pattern. The negative relationship survives an alternative ratio-based measure of geopolitical positioning, additional controls for exchange-rate conditions and a dynamic System GMM specification designed to address investment persistence and some endogeneity concerns. The authors nonetheless stress that these tests do not establish definitive causality.

The researchers caution that important limitations remain. The analysis focuses on Vietnam as a single host economy, uses aggregate country-level geopolitical indicators and does not distinguish among greenfield investment, mergers and acquisitions or individual industries. Time-varying bilateral policies such as trade agreements and tax arrangements may also remain imperfectly captured.

Future research could test whether the same relative-risk dynamic appears across other emerging economies and whether sectors such as manufacturing, technology, energy or green investment respond differently. Firm-level evidence could also clarify how companies adjust investment plans following geopolitical shocks and how supply-chain diversification interacts with political alignment.