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---

### Overview of Germany’s FDI trajectory
- Germany’s inward and outward foreign direct investment (FDI) followed the globalization of trade on an upward trend during the first decade of this century.
- Germany, as a highly developed and export-oriented economy, has benefited from FDI through:
  - access to new markets and expanded customer bases (Buch et al. 2005, Deutsche Bank 2005, Arnold and Hussinger 2010);
  - access to valuable resources (e.g., raw materials and energy sources; Agarwal et al. 1991).1
  - improved cost efficiency by setting up operations in countries with lower production costs (Becker et al. 2005; Becker at al. 2013);
  - potential diversification of risks.
- Inward FDI helped Germany expand jobs and investment, increase technology transfers, and boost exports.
- fDi Markets data contains 31 FDI projects abroad in the extraction in the energy or mineral sectors by German firms.1

### Recent trend breaks and contributing factors
- Germany’s FDI flows eased during:
  - the European Debt Crisis (2010–13),
  - the COVID-19 pandemic,
  - Russia’s war in Ukraine.
- Global forces contributing to recent falls in FDI include:
  - temporary supply-chain disruptions due to pandemic-related containment measures;
  - catch-up in labor costs in key production locations, especially China, which may reduce cost-efficiency incentives for outward FDI;
  - increasing difficulties in attracting qualified workers amid rapid population aging (GCEE 2022, 2023).
- Two additional factors highlighted:
  - surge in European energy prices following Russia’s invasion of Ukraine;
  - rising geopolitical tensions among major powers, contributing to geoeconomic fragmentation and increasing the number of new policy measures that restrict trade or FDI (Figure 2).

### Geopolitical fragmentation, industrial policy, and implications
- Geopolitical fragmentation2 is contributing to increased use of industrial policy (examples cited in the literature):
  - China’s “Made in China 2025”,
  - the EU’s European Chips Act,
  - the US’s Inflation Reduction Act (Juhász et al. 2023; Evenett et al. 2023).
- Increased geopolitical fragmentation and associated industrial policies could be factors behind the recent global easing of FDI flows.
- The recent slowdown in FDI could be:
  - temporary—if driven by time lags between reducing activity in insecure locations and initiating activity in more desirable locations for diversification;
  - persistent—if geopolitical fragmentation and industrial policies structurally reconfigure investment choices.

### Primary research focus and data
- Primary focus: examine the sensitivity of Germany’s outward FDI to:
  - (i) global geopolitical fragmentation and geopolitical risk;
  - (ii) destination countries’ energy prices.
- Datasets employed:
  - fDi Markets data (greenfield FDI project-level data referenced elsewhere in the paper);
  - Bundesbank’s Microdatabase Direct Investment (MiDi).

### How this paper contributes to the literature
- First to analyze the differential impact of geopolitical tensions on German FDI to destination countries of varying geopolitical distance.
- Builds on several strands of literature:
  - FDI and growth via productivity/knowledge spillovers (e.g., Javorcik 2004; Görg and Strobl 2001; Görg and Greenaway 2004; Keller 2021).
  - Economic impact of geopolitical tensions and the role of geography, historical, and cultural ties in FDI (Blonigen and Piger 2014 review).
  - Studies linking diplomatic and political relations with FDI flows (e.g., Desbordes 2010; Li et al. 2018; Desbordes and Vicard 2009).
  - Studies on Germany’s economic development and FDI over 2000–23 (e.g., Fadinger et al. 2023; Hünnekes et al. 2023; Buch et al. 2005; Buch and Lipponer 2007; Krautheim 2013; Buch et al. 2010).
  - Literature on Russia’s war in Ukraine and energy price impacts on outward FDI (e.g., Ari et al. 2022; Pescatori and Stuermer 2022; Garsous et al. 2020; OECD 2021).
- Novelty and additions:
  - Explicit examination of the interaction of geopolitical alignment and geopolitical tensions in shaping FDI flows.
  - Introduction of a new measure for geopolitical alignment.
  - Use of a structural gravity framework for FDI (e.g., Kleinert and Toubal 2010) combined with factor analyses to analyze breaks in trends and driving factors such as country characteristics, geographical and geopolitical distance, and energy cost differentials.

### Paper structure (as presented)
- Section 2: brief summary of related studies and how this paper adds to the literature.
- Section 3: description of key data used in the analysis.
- Section 4: exploration of trends in Germany’s inward and outward FDI over the last two decades through lenses of key geopolitical events, destination countries’ political relationships with Germany, and industry type (e.g., strategic vs. non-strategic; energy-intensive vs. non-energy-intensive).
- Section 5: application of a structural gravity framework for FDI and factor analyses to analyze breaks in trends and driving factors.
- Section 6: conclusions summarizing key findings.

### FDI data sources and coverage
- Main source: proprietary bilateral FDI data from fDi Markets (Financial Times service) covering January 2003–March 2023 and the period after Russia’s invasion of Ukraine.
- fDi Markets reports investment-level information for over 300,000 FDI instances between January 2003 and March 2023; more than 45,000 of those are either sourced from or destined to Germany.
- For each investment project fDi Markets records: source and destination countries, sector, activity (e.g., business services, sales, R&D), type (new investment or expansion), volume (in USD), and number of jobs created.
- Volume and jobs are often estimated; therefore most analysis relies on count data (supported by a high correlation between count and volume of bilateral investment).
- fDi Markets data serve as underlying data for global greenfield FDI reported in the World Investment Report by UNCTAD.
- fDi Markets does not track mergers and acquisitions and other international equity investments, investment projects that do not create new jobs, or companies that establish a foreign subsidiary without a physical company presence.

### Definition of strategic sectors
- Strategic sectors defined at the 3-digit level by combining earnings-call data from NL Analytics (Hassan et al. 2019) with a classification proposed by the Atlantic Council.
- Sectors mapped into ISIC Revision 4 3-digit classification identified as strategic by the Atlantic Council: semiconductors, telecommunications and 5G infrastructure, equipment needed for the green transition, pharmaceutical ingredients, and strategic and critical minerals.
- Additionally, among manufacturing and mining sectors, 3-digit industry groups in the top-3 deciles of mentions of terms related to reshoring, nearshoring, or friend-shoring in companies’ earnings calls between 2017–22 are included, except manufacture of textiles (excluded despite high mentions).

### Bundesbank MiDi data (complementary FDI data)
- Source: Bundesbank’s Microdatabase Direct Investment (MiDi), based on officially collected data on direct investments of German firms abroad and foreign-owned firms in Germany.
- Coverage period: 2002–21 (data coverage starts in 2001 but first one to two years are not satisfactory; most results use 2003–2021).
- Unit of observation: any investment relation—direct or indirect through an investment chain—including information on ultimate owners of German companies investing abroad.
- Reporting thresholds:
  - outward FDI—any company or private person that owns at least 10 percent of shares or voting rights in a foreign company whose balance sheet exceeds EUR3 million;
  - inward FDI—all investment relations for German firms whose balance sheet exceeds EUR3 million and at least 10 percent of shares or voting rights are owned by a single foreign company or individual or a group where all group members have the same economic interest.
- MiDi contains information on investment size and balance sheet details of foreign counterparts: source/destination country, sector of economic activity, turnover, number of employees, total of assets and structure, etc.
- MiDi data can be merged with other Bundesbank datasets such as Janis.

### Key MiDi statistics (annual average for 2002–21)
- German active MNEs: 10,931
- Affiliates: 25,638
- Affiliate turnover: EUR2.4 trillion
- Employees in affiliates: 6,621,112
- Stock of Investment: EUR985 (billion)
- Flow of FDI (net new investments per year): 28 (billion)
- Regional shares (share in total) from Table 1:
  - EU27: 41%
  - US: 14%
  - China: 8%
  - East Asia and Pacific: 8%
  - Americas (excl. US): 8%
  - Russia: 3%
  - Others: 18%
- Regional shares by other metrics (number / affiliate turnover / employees in affiliates / stock of investment / flow of FDI) as reported in Table 1:
  - EU27: 52% (Affiliates), 46% (Affiliate turnover), 45% (Employees in affiliates), 53% (Stock of Investment), 40% (Flow of FDI)
  - US: 10% (Affiliates), 19% (Affiliate turnover), 13% (Employees in affiliates), 19% (Stock of Investment), 16% (Flow of FDI)
  - China: 6% (Affiliates), 8% (Affiliate turnover), 8% (Employees in affiliates), 4% (Stock of Investment), 12% (Flow of FDI)
  - East Asia and Pacific: 8% (Affiliates), 8% (Affiliate turnover), 7% (Employees in affiliates), 7% (Stock of Investment), 10% (Flow of FDI)
  - Americas (excl. US): 7% (Affiliates), 6% (Affiliate turnover), 9% (Employees in affiliates), 6% (Stock of Investment), 8% (Flow of FDI)
  - Russia: 2% (Affiliates), 2% (Affiliate turnover), 2% (Employees in affiliates), 3% (Stock of Investment), 2% (Flow of FDI)
  - Others: 15% (Affiliates), 10% (Affiliate turnover), 15% (Employees in affiliates), 10% (Stock of Investment), 11% (Flow of FDI)

### Geopolitical distance measures
- Primary measure: Ideal Point Distance (IPD) of Germany to other countries’ UN voting behavior (Bailey and others 2017). IPD is available from 1946 to 2022 and varies across country pairs and over time; distance of Germany to other countries’ voting behavior is used.
- Alternative measure: bilateral arms transfer data from SIPRI measured in trend-indicator values (TIV); data range 1950–2022 but focus on period after the fall of the Soviet Union.
- Focus on exports of the top 10 arms-supplying countries since 1991 (cover around 90 percent of TIV of global arms exports over this period): US, Russia, France, Germany, the UK, China, Italy, the Netherlands, Israel, and Spain.
- Grouping for analysis: refer to China and Russia as the ‘China-Russia’ bloc and the other eight countries as the ‘US-led’ bloc (grouping fixed).
- Metric: for each country, the proportion of total arms imports received from exporters associated with each bloc; assignment rule for bloc membership: if proportion of arms imported from either bloc exceeds two-thirds over 2013-2022, country assigned to that bloc; otherwise country deemed “unaligned.”

### Geopolitical Risk (GPR)
- Index used: Geopolitical Risk Index (GPR) by Caldara and Iacoviello (2022).
- GPR starts in 1985 and tallies the share of news articles reporting on adverse geopolitical events each month in 10 English-language newspapers.
- Aggregation: index aggregated by year to match frequency of geopolitical distance measures.
- Index behavior: decrease at end of the Cold War; spikes starting September 11, 2001 and during wars in Afghanistan and Iraq; rise with Russia’s annexation of Crimea in 2014; elevated during election of US President Trump and subsequent US-China trade war; increases sharply in response to Russia’s invasion of Ukraine in early 2022.

### Energy prices (end-user natural gas prices)
- Data: end-user natural gas prices from the International Energy Agency (IEA) Prices dataset (quarterly, end-user prices for industry, reflect taxes and fees) for 38 countries.
- Germany’s end-user gas prices were relatively high in the early 2000s (above sample median), eased in the mid-2010s, and moved around the median through 2020.
- Germany’s end-user gas prices rose by 125 percent between Q1 2021 and Q4 2022.

### Overview and recent dynamics (FDI over the last two decades)
- Historical pattern: FDI broadly comoving among Germany, the rest of the EU, and the US.
- Recovery since the pandemic: Germany’s recovery weaker than other countries; Germany’s outward FDI remains about 25 percent below pre-pandemic levels.
- Regional recovery differences: recovery in Germany’s outward FDI to the rest of the EU, Middle East and Central Asia, and the US has been weaker than the rest of the EU’s outward FDI into these regions.
- Inward FDI to Germany: after a temporary increase, inward FDI declined to levels below the pandemic bottom, driven by a decline in FDI from the rest of the EU and China.
- Possible drivers of weak German FDI: weaker economic recovery from the pandemic, greater exposure to the energy-price shock from Russia’s war against Ukraine, and a possible wait-and-see approach by German firms amid rising geopolitical tensions.

### Shifts in country linkages
- Share of Germany’s FDI to EU27: historically around 30–40 percent; share peaked around 45 percent in 2021–22 then declined to below 40 percent by Q1 2023.
- Share to Russia: declined over the last decade, reaching zero by mid-2022.
- Share to China: declined from 10 percent in 2014–15 to 3 percent by Q1 2023.
- Share to US: declined from around 15 percent in 2020–21 to 10 percent by Q1 2023.

### Germany’s FDI by counterparts and sectors
- The share of FDI originating in Russia reached zero by mid-2022 for inward FDI to Germany.
- The share of China and remaining East and South Asia has declined moderately—3 percentage points each—since 2020.
- The share of the US in outward FDI declined from around 40 percent in total in the early 2000s to 25 percent in 2023, offset by a rise in the share of FDI originating in the EU and the rest of the world.
- Inward FDI in strategic and energy-intensive sectors has been decreasing since 2022.
  - Possible contributors: tightening of screening requirements for inward FDI and enhanced EU-wide cooperation since 2020.
  - Energy-price channel: Dutch TTF gas prices were 4 times higher than US Henry Hub gas prices in 2021; Dutch TTF gas prices rose by 269 percent in Q3 2022 compared to the 2021 average, while US Henry Hub gas prices rose by 113 percent during the same periods.
- Outward FDI in strategic sectors has been recovering from the pandemic bottom; outward FDI in energy-intensive sectors has remained flat.

### Vulnerability to FDI fragmentation: indices and geographic concentration
- Two indices used from IMF (2023) framework:
  - Geopolitical vulnerability index: for each source country, multiply the share of investment to each host country by the geopolitical distance between source and host countries.
  - Strategic vulnerability index: share of cumulative number of outward FDI projects in strategic sectors over 2010–2019 in total outward FDI projects over the same period.
- Cross-country comparisons:
  - Germany’s exposure to geopolitical risks (geopolitical vulnerability index) is in line with other advanced economies and with European countries.
  - Germany’s strategic vulnerability index is above the averages for other advanced economies and European countries (i.e., relatively high share of outward FDI in strategic sectors).
- Geographic concentration dynamics:
  - Geographic concentration of Germany’s outward FDI (flows) has generally been negatively correlated with the number of FDI projects (geographic concentration tends to intensify when the number of projects decreases).
  - In recent years, concentration has declined moderately despite a relatively unchanged number of projects, possibly reflecting increased de-risking efforts.

### Geopolitical distance measures and patterns of FDI
- IPD (UNGA voting) measure:
  - Germany tends to be geopolitically close to other European countries; distance greatest with Middle Eastern countries.
  - Germany’s distance from countries in Asia and the Americas is similar and less than its average distance from countries in Africa or the Middle East.
  - Since the mid-1990s: distance from China has narrowed considerably; distance from Russia widened; distance from the US has been rather stable.
  - Limitation: IPD may not accurately capture deterioration in relations with Russia after the invasion of Ukraine (IPD identifies the US as geopolitically farther from Germany than Russia).
- SIPRI-based geopolitical distance measure:
  - Generally confirms IPD patterns but classifies the US as a close ally and Russia in the opposite bloc (contrasting with IPD).
  - Identifies prominent “unaligned” countries, most notably India and South Africa.
  - Detects changing relationships faster (e.g., Pakistan’s rapprochement to China; shifts in Turkey’s relationship with Russia).
- FDI and geopolitical distance relationships:
  - About two-thirds of Germany’s total FDI over the last two decades went to countries in the closest quintile, largely EEA members and most G7 countries except the United States.
  - FDI in strategic sectors is broadly equally distributed across the closest three quintiles, but less so among remaining quintiles.
  - The negative correlation between Germany’s outward FDI and geopolitical distance intensified during 2017–22 compared to 2003–16.

### Econometric analysis: effects of geopolitical risk on outward FDI
- Motivation: geopolitical tensions rose sharply in the last decade, especially after Russia’s annexation of Crimea in 2014 and invasion of Ukraine in early 2022; GPR increased by 92 percent in 2022 from 2021.
- Empirical strategy:
  - Two-step approach using PPML (Poisson pseudo-maximum likelihood) for count data:
    - Step 1: regress number of Germany’s outward FDI projects to destination country i on log of geopolitical risk index (GPR) of Caldara and Iacoviello (2022), controlling for log GDP of Germany and destination country. Coefficient 훽훽_i captures sensitivity of country i’s FDI inflows from Germany to GPR.
    - Step 2: regress country-specific 훽훽_i on geopolitical distance/alignment measures (IPD, SIPRI-based blocs, share of arms imports from US and US allies).
  - Also re-expressed as panel gravity regression with interaction between GPR and geopolitical distance (PPML), allowing quarter fixed effects.
- Key econometric findings:
  - The coefficient of geopolitical distance on 훽훽_i is negative—higher distance implies higher sensitivity to geopolitical risks (i.e., falling FDI when geopolitical risks are high).
  - A 10 percent increase in GPR is associated with an additional decrease in Germany’s outward FDI projects in the CHN-RUS bloc by about 7 compared with the decline in Germany’s outward FDI projects in the US bloc.
  - Decline in Germany’s FDI projects into the unaligned bloc (relative to US bloc) is not statistically significantly different from zero.
  - Using share of arms imports from the US and US allies: coefficient positive—countries obtaining a lower share of arms from US-allied producers are more sensitive to geopolitical risks.
  - Robustness: results hold across both measures of geopolitical distance (SIPRI and IPD) and when using MiDi data for 2002–21 (stock of FDI in China-Russia bloc reacts stronger to increasing geopolitical risk than stock in US bloc).
  - Panel regression: interaction term coefficients indicate Germany’s FDI to China-Russia-bloc countries remains more sensitive to geopolitical risks compared with US-bloc countries.
  - Association with GDP growth: Germany’s outward FDI is associated more with Germany’s GDP growth than destination countries’ growth; a one percent increase in Germany’s GDP growth is associated with about one more German outward FDI project per quarter, ceteris paribus; association with recipient countries’ growth is not statistically significant.

### Effects of energy (gas) prices on Germany’s outward FDI
- Question: Do natural gas prices in destination countries affect German firms’ location choices, particularly for gas-intensive sectors (e.g., chemicals)?
- Empirical strategy:
  - Quarterly PPML regression at sector-destination-income-group-quarter level.
  - Dependent variable: number of outward FDI from Germany to sector s (aggregated to two groups—gas-intensive and non-gas-intensive, based on German Statistical Office definition) in destination country c in income group j in quarter t.
  - Key variable: indicator ퟙퟙ_P_cc > median country gas price interacted with energy-intensive sector dummy ퟙퟙ_s = gas-intensive.
  - Controls: sector-income-group-specific time fixed effects (휆휆_ssi) and log real GDP of destination.
- Findings:
  - Higher gas prices in a destination country are negatively associated with Germany’s FDI in energy-intensive sectors in that country.
  - Table 3 results:
    - Interaction term (High gas price dummy, lag × energy-intensive sector dummy): negative and significant (column (1) and (3)); when splitting sample, high gas prices only affect Germany’s FDI in energy-intensive sectors.
    - Share of arm imports from US and US allies × log geopolitical risk: large and significantly positive coefficient in column (3), indicating FDI in energy-intensive sectors is particularly sensitive to geopolitical alignment.
    - Pre-COVID robustness: restricting sample to pre-pandemic observations (column (4)) shows gas price impact remains significantly higher for energy-intensive sectors than for the rest.
  - Specific coefficient outcomes (from Table 3):
    - High gas price dummy, lag: -0.0802 (column (1)), -0.1456** (column (2)), -0.0812 (column (3)), -0.1118* (column (4)).
    - High gas price dummy, lag × energy-intensive sector dummy: -0.0832** (column (1)), -0.0707* (column (4)).
    - Share of arm imports from US and US allies × log geopolitical risk: 0.4834 (column (1)), 2.2890** (column (2)), 0.3006 (column (3)), -0.5527 (column (4)).
  - Observations and sample structure:
    - Observations: 2,137 (column (1) all), 609 (column (2) energy intensive), 1,528 (column (3) non energy intensive), 1,747 (column (4) pre COVID).
    - Quarter FE: YES for columns (1)–(4); Destination country FE: YES in column (3); Destination country income group × energy-intensive × quarter FE: YES in column (2).
  - Statistical significance notes: Robust standard errors reported; p-values: *** p<0.01, ** p<0.05, * p<0.1.
- Interpretation:
  - German firms reduce outward FDI in energy-intensive sectors when industrial gas prices in destination countries are high.
  - Geopolitical alignment interacts with these effects—energy-intensive FDI is particularly sensitive in countries less aligned with US and US allies.

### FDI recovery and levels (conclusions)
- Germany’s inward and outward FDI have seen a weaker post-pandemic recovery than the FDI of the US or the average for the rest of the EU.
- Germany’s FDI in the strategic and energy-intensive sectors has been declining during the last several quarters.
- As of Q1 2023, Germany’s outward and inward FDI remain about 25 and 35 percent below pre-pandemic levels, respectively.
- Germany’s relatively weak FDI activities may reflect its weaker economic recovery from the pandemic, as well as its greater exposure to the energy-price shock from Russia’s war against Ukraine.
- It is also possible that German firms are taking a wait-and-see approach to restarting their FDI activities following the pandemic amid rising geopolitical tensions among large economic blocs.

### Geopolitical distance and FDI linkages (conclusions)
- Germany’s FDI linkages with geopolitically distant countries have been weakening since the Global Financial Crisis.
- The relationship between FDI and geopolitical distance has strengthened since the beginning of the Trump administration.
- Over the last two decades, about two-thirds of Germany’s total FDI went to the closest quintile of countries, which is largely composed of EEA members and most G7 countries, except for the US.
- FDI in strategic sectors is broadly equally distributed across the closest three quintile countries, but less among countries in the remaining quintiles.
- Germany’s FDI linkages with geopolitically close countries have increased while those with geopolitically distant countries have declined since 2015.
- The negative correlation between Germany’s outward FDI and its geopolitical distance has intensified during the period 2017–22 compared to the period 2003–16.

### Regression and empirical findings (conclusions)
- Regression analyses find that:
  - Germany’s FDI flows to China-Russia-bloc countries are more sensitive to geopolitical risks than flows to US-bloc countries.
  - Germany’s FDI in energy-intensive sectors decreases as destination countries’ energy costs increase.

*Source: Germany’s Foreign Direct Investment in Times of Geopolitical Fragmentation, Working Paper No. WP/2024/130*

### 1. Introduction ........................................................................................................

### 1. Introduction

### Overview of Germany’s FDI trajectory
- Germany’s inward and outward foreign direct investment (FDI) followed the globalization of trade on an upward trend during the first decade of this century.
- Germany, as a highly developed and export-oriented economy, has benefited from FDI through:
  - access to new markets and expanded customer bases (Buch et al. 2005, Deutsche Bank 2005, Arnold and Hussinger 2010);
  - access to valuable resources (e.g., raw materials and energy sources; Agarwal et al. 1991).1
  - improved cost efficiency by setting up operations in countries with lower production costs (Becker et al. 2005; Becker at al. 2013);
  - potential diversification of risks.
- Inward FDI helped Germany expand jobs and investment, increase technology transfers, and boost exports.
- fDi Markets data contains 31 FDI projects abroad in the extraction in the energy or mineral sectors by German firms.1

### Recent trend breaks and contributing factors
- Germany’s FDI flows eased during:
  - the European Debt Crisis (2010–13),
  - the COVID-19 pandemic,
  - Russia’s war in Ukraine.
- Global forces contributing to recent falls in FDI include:
  - temporary supply-chain disruptions due to pandemic-related containment measures;
  - catch-up in labor costs in key production locations, especially China, which may reduce cost-efficiency incentives for outward FDI;
  - increasing difficulties in attracting qualified workers amid rapid population aging (GCEE 2022, 2023).
- Two additional factors highlighted:
  - surge in European energy prices following Russia’s invasion of Ukraine;
  - rising geopolitical tensions among major powers, contributing to geoeconomic fragmentation and increasing the number of new policy measures that restrict trade or FDI (Figure 2).

### Geopolitical fragmentation, industrial policy, and implications
- Geopolitical fragmentation2 is contributing to increased use of industrial policy (examples cited in the literature):
  - China’s “Made in China 2025”,
  - the EU’s European Chips Act,
  - the US’s Inflation Reduction Act (Juhász et al. 2023; Evenett et al. 2023).
- Increased geopolitical fragmentation and associated industrial policies could be factors behind the recent global easing of FDI flows.
- The recent slowdown in FDI could be:
  - temporary—if driven by time lags between reducing activity in insecure locations and initiating activity in more desirable locations for diversification;
  - persistent—if geopolitical fragmentation and industrial policies structurally reconfigure investment choices.

### Primary research focus and data
- Primary focus: examine the sensitivity of Germany’s outward FDI to:
  - (i) global geopolitical fragmentation and geopolitical risk;
  - (ii) destination countries’ energy prices.
- Datasets employed:
  - fDi Markets data (greenfield FDI project-level data referenced elsewhere in the paper);
  - Bundesbank’s Microdatabase Direct Investment (MiDi).

### How this paper contributes to the literature
- First to analyze the differential impact of geopolitical tensions on German FDI to destination countries of varying geopolitical distance.
- Builds on several strands of literature:
  - FDI and growth via productivity/knowledge spillovers (e.g., Javorcik 2004; Görg and Strobl 2001; Görg and Greenaway 2004; Keller 2021).
  - Economic impact of geopolitical tensions and the role of geography, historical, and cultural ties in FDI (Blonigen and Piger 2014 review).
  - Studies linking diplomatic and political relations with FDI flows (e.g., Desbordes 2010; Li et al. 2018; Desbordes and Vicard 2009).
  - Studies on Germany’s economic development and FDI over 2000–23 (e.g., Fadinger et al. 2023; Hünnekes et al. 2023; Buch et al. 2005; Buch and Lipponer 2007; Krautheim 2013; Buch et al. 2010).
  - Literature on Russia’s war in Ukraine and energy price impacts on outward FDI (e.g., Ari et al. 2022; Pescatori and Stuermer 2022; Garsous et al. 2020; OECD 2021).
- Novelty and additions:
  - Explicit examination of the interaction of geopolitical alignment and geopolitical tensions in shaping FDI flows.
  - Introduction of a new measure for geopolitical alignment.
  - Use of a structural gravity framework for FDI (e.g., Kleinert and Toubal 2010) combined with factor analyses to analyze breaks in trends and driving factors such as country characteristics, geographical and geopolitical distance, and energy cost differentials.

### Paper structure (as presented)
- Section 2: brief summary of related studies and how this paper adds to the literature.
- Section 3: description of key data used in the analysis.
- Section 4: exploration of trends in Germany’s inward and outward FDI over the last two decades through lenses of key geopolitical events, destination countries’ political relationships with Germany, and industry type (e.g., strategic vs. non-strategic; energy-intensive vs. non-energy-intensive).
- Section 5: application of a structural gravity framework for FDI and factor analyses to analyze breaks in trends and driving factors.
- Section 6: conclusions summarizing key findings.

*Source: wpiea2024130-print-pdf - 1. Introduction*

### 3. Data and Background Statistics

### 3. Data and Background Statistics

### FDI data sources and coverage
- Main source: proprietary bilateral FDI data from fDi Markets (Financial Times service) covering January 2003–March 2023 and the period after Russia’s invasion of Ukraine.
- fDi Markets reports investment-level information for over 300,000 FDI instances between January 2003 and March 2023; more than 45,000 of those are either sourced from or destined to Germany.
- For each investment project fDi Markets records: source and destination countries, sector, activity (e.g., business services, sales, R&D), type (new investment or expansion), volume (in USD), and number of jobs created.
- Volume and jobs are often estimated; therefore most analysis relies on count data (supported by a high correlation between count and volume of bilateral investment).
- fDi Markets data serve as underlying data for global greenfield FDI reported in the World Investment Report by UNCTAD.
- fDi Markets does not track mergers and acquisitions and other international equity investments, investment projects that do not create new jobs, or companies that establish a foreign subsidiary without a physical company presence.

### Definition of strategic sectors
- Strategic sectors defined at the 3-digit level by combining earnings-call data from NL Analytics (Hassan et al. 2019) with a classification proposed by the Atlantic Council.
- Sectors mapped into ISIC Revision 4 3-digit classification identified as strategic by the Atlantic Council: semiconductors, telecommunications and 5G infrastructure, equipment needed for the green transition, pharmaceutical ingredients, and strategic and critical minerals.
- Additionally, among manufacturing and mining sectors, 3-digit industry groups in the top-3 deciles of mentions of terms related to reshoring, nearshoring, or friend-shoring in companies’ earnings calls between 2017–22 are included, except manufacture of textiles (excluded despite high mentions).

### Bundesbank MiDi data (complementary FDI data)
- Source: Bundesbank’s Microdatabase Direct Investment (MiDi), based on officially collected data on direct investments of German firms abroad and foreign-owned firms in Germany.
- Coverage period: 2002–21 (data coverage starts in 2001 but first one to two years are not satisfactory; most results use 2003–2021).
- Unit of observation: any investment relation—direct or indirect through an investment chain—including information on ultimate owners of German companies investing abroad.
- Reporting thresholds: outward FDI—any company or private person that owns at least 10 percent of shares or voting rights in a foreign company whose balance sheet exceeds EUR3 million; inward FDI—all investment relations for German firms whose balance sheet exceeds EUR3 million and at least 10 percent of shares or voting rights are owned by a single foreign company or individual or a group where all group members have the same economic interest.
- MiDi contains information on investment size and balance sheet details of foreign counterparts: source/destination country, sector of economic activity, turnover, number of employees, total of assets and structure, etc.
- MiDi data can be merged with other Bundesbank datasets such as Janis.

### Key MiDi statistics (annual average for 2002–21)
- German active MNEs: 10,931
- Affiliates: 25,638
- Affiliate turnover: EUR2.4 trillion
- Employees in affiliates: 6,621,112
- Stock of Investment: EUR985 (billion)
- Flow of FDI (net new investments per year): 28 (billion)
- Regional shares (share in total) from Table 1:
  - EU27: 41%
  - US: 14%
  - China: 8%
  - East Asia and Pacific: 8%
  - Americas (excl. US): 8%
  - Russia: 3%
  - Others: 18%
- Regional shares by other metrics (number / affiliate turnover / employees in affiliates / stock of investment / flow of FDI) as reported in Table 1 (preserved here as presented):
  - EU27: 52% (Affiliates), 46% (Affiliate turnover), 45% (Employees in affiliates), 53% (Stock of Investment), 40% (Flow of FDI)
  - US: 10% (Affiliates), 19% (Affiliate turnover), 13% (Employees in affiliates), 19% (Stock of Investment), 16% (Flow of FDI)
  - China: 6% (Affiliates), 8% (Affiliate turnover), 8% (Employees in affiliates), 4% (Stock of Investment), 12% (Flow of FDI)
  - East Asia and Pacific: 8% (Affiliates), 8% (Affiliate turnover), 7% (Employees in affiliates), 7% (Stock of Investment), 10% (Flow of FDI)
  - Americas (excl. US): 7% (Affiliates), 6% (Affiliate turnover), 9% (Employees in affiliates), 6% (Stock of Investment), 8% (Flow of FDI)
  - Russia: 2% (Affiliates), 2% (Affiliate turnover), 2% (Employees in affiliates), 3% (Stock of Investment), 2% (Flow of FDI)
  - Others: 15% (Affiliates), 10% (Affiliate turnover), 15% (Employees in affiliates), 10% (Stock of Investment), 11% (Flow of FDI)

### Geopolitical distance measures
- Primary measure: Ideal Point Distance (IPD) of Germany to other countries’ UN voting behavior (Bailey and others 2017). IPD is available from 1946 to 2022 and varies across country pairs and over time; distance of Germany to other countries’ voting behavior is used.
- Alternative measure: bilateral arms transfer data from SIPRI measured in trend-indicator values (TIV); data range 1950–2022 but focus on period after the fall of the Soviet Union.
- Focus on exports of the top 10 arms-supplying countries since 1991 (cover around 90 percent of TIV of global arms exports over this period): US, Russia, France, Germany, the UK, China, Italy, the Netherlands, Israel, and Spain.
- Grouping for analysis: refer to China and Russia as the ‘China-Russia’ bloc and the other eight countries as the ‘US-led’ bloc (grouping fixed).
- Metric: for each country, the proportion of total arms imports received from exporters associated with each bloc; assignment rule for bloc membership: if proportion of arms imported from either bloc exceeds two-thirds over 2013-2022, country assigned to that bloc; otherwise country deemed “unaligned.”

### Geopolitical Risk (GPR)
- Index used: Geopolitical Risk Index (GPR) by Caldara and Iacoviello (2022).
- GPR starts in 1985 and tallies the share of news articles reporting on adverse geopolitical events each month in 10 English-language newspapers.
- Aggregation: index aggregated by year to match frequency of geopolitical distance measures.
- Index behavior: decrease at end of the Cold War; spikes starting September 11, 2001 and during wars in Afghanistan and Iraq; rise with Russia’s annexation of Crimea in 2014; elevated during election of US President Trump and subsequent US-China trade war; increases sharply in response to Russia’s invasion of Ukraine in early 2022.

### Energy prices (end-user natural gas prices)
- Data: end-user natural gas prices from the International Energy Agency (IEA) Prices dataset (quarterly, end-user prices for industry, reflect taxes and fees) for 38 countries.
- Germany’s end-user gas prices were relatively high in the early 2000s (above sample median), eased in the mid-2010s, and moved around the median through 2020.
- Germany’s end-user gas prices rose by 125 percent between Q1 2021 and Q4 2022.

### 4. German FDI over the Last Two Decades

### Overview and recent dynamics
- Historical pattern: FDI broadly comoving among Germany, the rest of the EU, and the US.
- Recovery since the pandemic: Germany’s recovery weaker than other countries; Germany’s outward FDI remains about 25 percent below pre-pandemic levels.
- Regional recovery differences: recovery in Germany’s outward FDI to the rest of the EU, Middle East and Central Asia, and the US has been weaker than the rest of the EU’s outward FDI into these regions.
- Inward FDI to Germany: after a temporary increase, inward FDI declined to levels below the pandemic bottom, driven by a decline in FDI from the rest of the EU and China.
- Possible drivers of weak German FDI: weaker economic recovery from the pandemic, greater exposure to the energy-price shock from Russia’s war against Ukraine, and a possible wait-and-see approach by German firms amid rising geopolitical tensions.

### Shifts in country linkages
- Share of Germany’s FDI to EU27: historically around 30–40 percent; share peaked around 45 percent in 2021–22 then declined to below 40 percent by Q1 2023.
- Share to Russia: declined over the last decade, reaching zero by mid-2022.
- Share to China: declined from 10 percent in 2014–15 to 3 percent by Q1 2023.
- Share to US: declined from around 15 percent in 2020–21 to 10 percent by Q1 2023.

*Source: IMF Working Paper — 3. Data and Background Statistics (wpiea2024130-print-pdf).*

### 2023. Meanwhile, the share of East and South Asia (excluding China) and North and Latin America (excluding

### wpiea2024130-print-pdf - 2023. Meanwhile, the share of East and South Asia (excluding China) and North and Latin America (excluding

### Germany’s FDI by counterparts and sectors
- The share of FDI originating in Russia reached zero by mid-2022 for inward FDI to Germany.
- The share of China and remaining East and South Asia has declined moderately—3 percentage points each—since 2020.
- The share of the US in outward FDI declined from around 40 percent in total in the early 2000s to 25 percent in 2023, offset by a rise in the share of FDI originating in the EU and the rest of the world.
- Inward FDI in strategic and energy-intensive sectors has been decreasing since 2022.
  - Possible contributors: tightening of screening requirements for inward FDI and enhanced EU-wide cooperation since 2020.
  - Energy-price channel: Dutch TTF gas prices were 4 times higher than US Henry Hub gas prices in 2021; Dutch TTF gas prices rose by 269 percent in Q3 2022 compared to the 2021 average, while US Henry Hub gas prices rose by 113 percent during the same periods.
- Outward FDI in strategic sectors has been recovering from the pandemic bottom; outward FDI in energy-intensive sectors has remained flat.

### Vulnerability to FDI fragmentation: indices and geographic concentration
- Two indices used from IMF (2023) framework:
  - Geopolitical vulnerability index: for each source country, multiply the share of investment to each host country by the geopolitical distance between source and host countries.
  - Strategic vulnerability index: share of cumulative number of outward FDI projects in strategic sectors over 2010–2019 in total outward FDI projects over the same period.
- Cross-country comparisons:
  - Germany’s exposure to geopolitical risks (geopolitical vulnerability index) is in line with other advanced economies and with European countries.
  - Germany’s strategic vulnerability index is above the averages for other advanced economies and European countries (i.e., relatively high share of outward FDI in strategic sectors).
- Geographic concentration dynamics:
  - Geographic concentration of Germany’s outward FDI (flows) has generally been negatively correlated with the number of FDI projects (geographic concentration tends to intensify when the number of projects decreases).
  - In recent years, concentration has declined moderately despite a relatively unchanged number of projects, possibly reflecting increased de-risking efforts.

### Geopolitical distance measures and patterns of FDI
- IPD (UNGA voting) measure:
  - Germany tends to be geopolitically close to other European countries; distance greatest with Middle Eastern countries.
  - Germany’s distance from countries in Asia and the Americas is similar and less than its average distance from countries in Africa or the Middle East.
  - Since the mid-1990s: distance from China has narrowed considerably; distance from Russia widened; distance from the US has been rather stable.
  - Limitation: IPD may not accurately capture deterioration in relations with Russia after the invasion of Ukraine (IPD identifies the US as geopolitically farther from Germany than Russia).
- SIPRI-based geopolitical distance measure:
  - Generally confirms IPD patterns but classifies the US as a close ally and Russia in the opposite bloc (contrasting with IPD).
  - Identifies prominent “unaligned” countries, most notably India and South Africa.
  - Detects changing relationships faster (e.g., Pakistan’s rapprochement to China; shifts in Turkey’s relationship with Russia).
- FDI and geopolitical distance relationships:
  - About two-thirds of Germany’s total FDI over the last two decades went to countries in the closest quintile, largely EEA members and most G7 countries except the United States.
  - FDI in strategic sectors is broadly equally distributed across the closest three quintiles, but less so among remaining quintiles.
  - The negative correlation between Germany’s outward FDI and geopolitical distance intensified during 2017–22 compared to 2003–16.

### Econometric analysis: effects of geopolitical risk on outward FDI
- Motivation: geopolitical tensions rose sharply in the last decade, especially after Russia’s annexation of Crimea in 2014 and invasion of Ukraine in early 2022; GPR increased by 92 percent in 2022 from 2021.
- Empirical strategy:
  - Two-step approach using PPML (Poisson pseudo-maximum likelihood) for count data:
    - Step 1: regress number of Germany’s outward FDI projects to destination country i on log of geopolitical risk index (GPR) of Caldara and Iacoviello (2022), controlling for log GDP of Germany and destination country. Coefficient 훽훽_i captures sensitivity of country i’s FDI inflows from Germany to GPR.
    - Step 2: regress country-specific 훽훽_i on geopolitical distance/alignment measures (IPD, SIPRI-based blocs, share of arms imports from US and US allies).
  - Also re-expressed as panel gravity regression with interaction between GPR and geopolitical distance (PPML), allowing quarter fixed effects.
- Key econometric findings:
  - The coefficient of geopolitical distance on 훽훽_i is negative—higher distance implies higher sensitivity to geopolitical risks (i.e., falling FDI when geopolitical risks are high).
  - A 10 percent increase in GPR is associated with an additional decrease in Germany’s outward FDI projects in the CHN-RUS bloc by about 7 compared with the decline in Germany’s outward FDI projects in the US bloc.
  - Decline in Germany’s FDI projects into the unaligned bloc (relative to US bloc) is not statistically significantly different from zero.
  - Using share of arms imports from the US and US allies: coefficient positive—countries obtaining a lower share of arms from US-allied producers are more sensitive to geopolitical risks.
  - Robustness: results hold across both measures of geopolitical distance (SIPRI and IPD) and when using MiDi data for 2002–21 (stock of FDI in China-Russia bloc reacts stronger to increasing geopolitical risk than stock in US bloc).
  - Panel regression: interaction term coefficients indicate Germany’s FDI to China-Russia-bloc countries remains more sensitive to geopolitical risks compared with US-bloc countries.
  - Association with GDP growth: Germany’s outward FDI is associated more with Germany’s GDP growth than destination countries’ growth; a one percent increase in Germany’s GDP growth is associated with about one more German outward FDI project per quarter, ceteris paribus; association with recipient countries’ growth is not statistically significant.

### Effects of energy (gas) prices on Germany’s outward FDI
- Question: Do natural gas prices in destination countries affect German firms’ location choices, particularly for gas-intensive sectors (e.g., chemicals)?
- Empirical strategy:
  - Quarterly PPML regression at sector-destination-income-group-quarter level.
  - Dependent variable: number of outward FDI from Germany to sector s (aggregated to two groups—gas-intensive and non-gas-intensive, based on German Statistical Office definition) in destination country c in income group j in quarter t.
  - Key variable: indicator ퟙퟙ_P_cc > median country gas price interacted with energy-intensive sector dummy ퟙퟙ_s = gas-intensive.
  - Controls: sector-income-group-specific time fixed effects (휆휆_ssi) and log real GDP of destination.
- Findings:
  - Higher gas prices in a destination country are negatively associated with Germany’s FDI in energy-intensive sectors in that country.
  - Table 3 results:
    - Interaction term (High gas price dummy, lag × energy-intensive sector dummy): negative and significant (column (1) and (3)); when splitting sample, high gas prices only affect Germany’s FDI in energy-intensive sectors.
    - Share of arm imports from US and US allies × log geopolitical risk: large and significantly positive coefficient in column (3), indicating FDI in energy-intensive sectors is particularly sensitive to geopolitical alignment.
    - Pre-COVID robustness: restricting sample to pre-pandemic observations (column (4)) shows gas price impact remains significantly higher for energy-intensive sectors than for the rest.
  - Specific coefficient outcomes (from Table 3):
    - High gas price dummy, lag: -0.0802 (column (1)), -0.1456** (column (2)), -0.0812 (column (3)), -0.1118* (column (4)).
    - High gas price dummy, lag × energy-intensive sector dummy: -0.0832** (column (1)), -0.0707* (column (4)).
    - Share of arm imports from US and US allies × log geopolitical risk: 0.4834 (column (1)), 2.2890** (column (2)), 0.3006 (column (3)), -0.5527 (column (4)).
  - Observations and sample structure:
    - Observations: 2,137 (column (1) all), 609 (column (2) energy intensive), 1,528 (column (3) non energy intensive), 1,747 (column (4) pre COVID).
    - Quarter FE: YES for columns (1)–(4); Destination country FE: YES in column (3); Destination country income group × energy-intensive × quarter FE: YES in column (2).
  - Statistical significance notes: Robust standard errors reported; p-values: *** p<0.01, ** p<0.05, * p<0.1.
- Interpretation:
  - German firms reduce outward FDI in energy-intensive sectors when industrial gas prices in destination countries are high.
  - Geopolitical alignment interacts with these effects—energy-intensive FDI is particularly sensitive in countries less aligned with US and US allies.

*IMF WORKING PAPERS Germany’s Foreign Direct Investment — INTERNATIONAL MONETARY FUND*

### 6. Conclusions

### 6. Conclusions

### FDI recovery and levels
- Germany’s inward and outward FDI have seen a weaker post-pandemic recovery than the FDI of the US or the average for the rest of the EU.
- Germany’s FDI in the strategic and energy-intensive sectors has been declining during the last several quarters.
- As of Q1 2023, Germany’s outward and inward FDI remain about 25 and 35 percent below pre-pandemic levels, respectively.
- Germany’s relatively weak FDI activities may reflect its weaker economic recovery from the pandemic, as well as its greater exposure to the energy-price shock from Russia’s war against Ukraine.
- It is also possible that German firms are taking a wait-and-see approach to restarting their FDI activities following the pandemic amid rising geopolitical tensions among large economic blocs.

### Geopolitical distance and FDI linkages
- Germany’s FDI linkages with geopolitically distant countries have been weakening since the Global Financial Crisis.
- The relationship between FDI and geopolitical distance has strengthened since the beginning of the Trump administration.
- Over the last two decades, about two-thirds of Germany’s total FDI went to the closest quintile of countries, which is largely composed of EEA members and most G7 countries, except for the US.
- FDI in strategic sectors is broadly equally distributed across the closest three quintile countries, but less among countries in the remaining quintiles.
- Germany’s FDI linkages with geopolitically close countries have increased while those with geopolitically distant countries have declined since 2015.
- The negative correlation between Germany’s outward FDI and its geopolitical distance has intensified during the period 2017–22 compared to the period 2003–16.

### Regression and empirical findings
- Regression analyses find that:
  - Germany’s FDI flows to China-Russia-bloc countries are more sensitive to geopolitical risks than flows to US-bloc countries.
  - Germany’s FDI in energy-intensive sectors decreases as destination countries’ energy costs increase.

*Source: Germany’s Foreign Direct Investment in Times of Geopolitical Fragmentation, Working Paper No. WP/2024/130*

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_Source: https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024130-print-pdf.pdf_