Divestment and Geopolitics: How political and geopolitical tensions impact on firms decision to divest

With the deterioration of international relations and a shift from a rule-based to a more power-based international order, FDI is increasingly being seen as a loophole for foreign countries to seize power and thus as a security threat. This is mirrored in policies such as the EU Investment Screening Regulation, which entered into force in late 2020. But although FDI flows have increased in the last decades, this trend seems to stagnate in the past years (Giroud & Ivarsson 2020). Part of this slow down can partially be attributed to the pandemic, however, the shortening of global supply and value chains and the reshoring of production have already started before the disruptions due to COVID-19. An important driver for this trend and thus for firms to reduce investment seem to be ongoing political and geopolitical tensions (see, e.g. Suzuki, 2021; Ernst & Young, 2018). It can be expected that these tensions do not only lead to a reduction in FDI, but also to divestment (i.e. multinationals pulling out of host countries). However, in contrast to FDI, divestment and its drivers are largely neglected in the literature (Borga et al., 2020), although divestment, i.e. shutting down affiliates and moving production to a different country, definitely has effects on the host country. This paper aims to shed light on the drivers behind the decision of multinational firms to divest, in particular on the claim that political and geopolitical tensions can be made responsible for such decisions. To examine the influence of conflict on divestment, we make use of the gravity equation of international trade (Anderson & Van Wincoop, 2003). In terms of divestment data, we use the Microdatabase Direct investment by Deutsche Bundesbank. In a first step, data on armed conflict, one-sided violence and non-state conflict by Uppsala Conflict Data Program is taken to investigate whether firms pull out of the host country in case of an actual conflict, and whether an anticipation effect or lagged effect is visible. In a second step, we use the Geopolitical Risk Index (Caldara & Iacoviello 2022) to examine whether geopolitical tensions have an impact on firms decision to divest. Anderson, J. E., & Van Wincoop, E. (2003). Gravity with gravitas: A solution to the border puzzle. American economic review, 93(1), 170-192. Borga M., Ibarlucea-Flores P., and Sztajerowska, M., 2020. Divestment Decisions by Multinational Enterprises: Trends, Impacts, and Drivers – A Cross-country Firm-level Perspective, OECD Working Papers on International Investment, No. 2019/03, OECD Publishing, Paris. Caldara, D., & Iacoviello, M. (2022). Measuring geopolitical risk. American Economic Review, (forthcoming). Ernst & Young (2018). How can divesting fuel your future growth? Global Corporate Divestment Study 2018. Giroud, A., & Ivarsson, I. (2020). World Investment Report 2020: International production beyond the pandemic. UNCTAD Suzuki, H. (2021). Building Resilient Global Supply Chains. The Geopolitics of the Indo-Pacific Region. Washington, DC: Center for Strategic & International Studies (CSIS).