How do trade restrictiveness and trade policy uncertainty affect FDI? An empirical investigation

In the context of rising economic fragmentation, trade restrictions have become as a much-used policy instrument, justified on grounds of national security, support for domestic production and jobs or a corrective response to perceived unfair trade practices. Alongside rising restrictions, trade policy uncertainty has reached historically high levels across a broad set of economies, resulting in a less stable and less predictable global trading environment. Using bilateral foreign direct investment (FDI) flows data and dynamic gravity-based local projections, we show that trade restrictions and trade policy uncertainty in host countries trigger economically significant and persistent declines in FDI inflows, especially from low-and middle-income source countries. Adverse effects are mitigated by countercyclical fiscal policy and stable exchange rates, but are amplified by greater capital account openness. Stronger global value chain integration amplifies the impact of trade restrictions and uncertainty shocks, while greater geopolitical distance strengthens the effects of trade restrictions but reduces the sensitivity to trade policy uncertainty. Results are robust to a range of specifications, including instrumental variable and difference-in-differences approaches.

Jonathan Ostry gratefully acknowledges support from the Munk School of Global Affairs and Public Policy at the University of Toronto, and helpful comments from participants at the G20 Global Financial Stability Conference in Seoul (September 2025) and at a Bruegel seminar (October 2025), where earlier versions of this paper were presented. The views expressed in this paper are those of the authors and do not necessarily represent the views of the International Monetary Fund, its Executive Board or IMF management.