Geopolitical Risk and Foreign Direct Investment Inflows: The Moderating Role of Water and Energy Risks

Abstract

Using a panel of 43 economies between 1985 and 2022, this paper establishes a link between FDI inflows and geopolitical risk. We distinguish the idiosyncratic component of geopolitical risk from the global geopolitical risk index provided by Caldara and Iacoviello (2022). We then incorporate both global and idiosyncratic risks into a static FDI regression model, controlling for other economic and institutional determinants. Our findings suggest that both global and idiosyncratic geopolitical risks pose significant obstacles to FDI inflows. Additionally, we investigate whether water and energy risks, when interacting with geopolitical risk, influence the behaviour of international investors. To test this hypothesis, we estimate the interaction effect of water stress and energy intensity as proxies for water and energy risks, respectively. Our findings imply that foreign investors perceive high energy intensity and water stress as moderating factors that could motivate host country policymakers to avoid involvement in geopolitical confrontations, thereby supporting peacebuilding to prevent or resolute conflicts.

Keywords: foreign direct investment inflows, geopolitical risk, interaction effects, panel data analysis

JEL Classification: F2, F5, M2