Financial Subsidies Boost FDI but Reinforce, Not Reshape, Comparative Advantages

An IMF study finds that only financial subsidies, such as loans and guarantees, significantly boost cross-border greenfield investment by about 7%. These subsidies tend to reinforce existing comparative advantages rather than create new ones.

In a timely and expansive analysis, IMF economists Michele Ruta and Monika Sztajerowska explore how government subsidies influence the direction of cross-border greenfield investment, offering fresh empirical evidence that brings clarity to a long-standing policy debate. Their April 2025 working paper, produced under the auspices of the International Monetary Fund’s Strategy, Policy and Review Department, draws from collaborative insights across academic and research institutions, including the University of St. Gallen, OECD, Georgetown University, and the London School of Economics. The paper zeroes in on the global surge in industrial policy over the last decade, especially the use of subsidies, and assesses their tangible impact on foreign direct investment (FDI) using a vast panel dataset from 2010 to 2020.

The Rise of Modern Industrial Policy

Over the past decade, industrial policy has re-emerged as a centerpiece of economic strategy in both advanced and emerging economies. Far from the protectionist approaches of the past, today’s industrial policies are often outward-looking, aimed at strengthening export sectors, supply chain resilience, and technological self-sufficiency. Flagship programs such as the U.S. CHIPS and Science Act, the European Green Deal, and China’s “Made in China 2025” reflect this shift. Crucially, these policies often do not discriminate between domestic and foreign firms—more than 40 percent of firms receiving U.S. CHIPS Act subsidies, for example, are foreign-owned. As a result, a key question arises: are these subsidies reshaping global investment flows, or merely reinforcing existing patterns?

What the Data Say: Not All Subsidies Are Equal

To address this, Ruta and Sztajerowska construct an extensive dataset, combining fDi Markets data on announced greenfield investment projects with subsidy records from the Global Trade Alert (GTA) for 243 countries and 93 manufacturing sectors over an 11-year span. Greenfield FDI—where firms build new operations from scratch is singled out for its economic impact, including job creation and technology transfer. Employing a difference-in-differences framework and a rich array of fixed effects, the authors find that subsidies in general have no statistically significant average effect on FDI. However, when broken down by type, the story changes: financial subsidies, such as state loans, loan guarantees, and interest support, consistently lead to a 7 percent increase in new greenfield investment projects. In contrast, grants, tax breaks, production, and export subsidies show no significant effect.

The study suggests that the superior performance of financial subsidies may lie in how they are administered. Such subsidies are typically routed through banks or financial intermediaries, relying on financial criteria rather than political discretion. This reduces administrative burden, encourages access by foreign firms, and allows interaction with global capital markets. Grants and production subsidies, by contrast, often require lengthy applications, satisfy policy-specific conditions like local content rules, and carry more risk of politicization or misallocation.

Subsidies Work Best Where Comparative Advantage Already Exists

A deeper dive into the data reveals that the impact of subsidies is far from uniform. Financial subsidies are particularly effective in capital-intensive sectors, where upfront investment costs are high. These sectors—ranging from machinery to electronics and transportation equipment are also where multinational enterprises (MNEs) are more likely to operate. In countries with high capital endowments, the positive effects of subsidies on FDI are especially pronounced. In other words, rather than creating new patterns of specialization, subsidies tend to amplify existing comparative advantages. Interestingly, the strength of local capital markets plays a modifying role: financial subsidies seem to deliver the strongest results in countries that are capital-rich but suffer from underdeveloped financial systems, suggesting that subsidies can act as a partial remedy to structural financing constraints.

When Subsidies Backfire: The Importance of Access

Access to subsidies is critical. In sectors where foreign firms are already well-represented and contribute significantly to value-added, subsidies are more likely to encourage new investment. However, when access is limited or biased toward domestic incumbents, subsidies can have the opposite effect, crowding out foreign investors and entrenching market concentration. The study highlights that in sectors where foreign-owned firms are less prominent, the presence of subsidies may deter FDI. These findings align with broader political economy literature that warns against state capture and uncompetitive favoritism in the allocation of industrial support.

A Call for Smarter, Not Just Bigger, Subsidies

Ruta and Sztajerowska’s findings are highly relevant in an era of growing subsidy activism. They challenge the assumption that more subsidies will automatically attract more foreign investment. Instead, the design, type, and targeting of subsidies are what matter. The study stops short of assessing welfare implications, but the authors warn that global subsidy competition may entrench disparities between wealthy nations with the fiscal room to subsidize and poorer ones that cannot compete. This creates potential inefficiencies in global capital allocation and raises equity concerns.

Ultimately, the paper underscores the need for thoughtful industrial policy that recognizes the nuances of FDI behavior and comparative advantage. Rather than relying on broad-brush subsidies, governments should tailor support to where it can be most effective, namely, in reducing genuine investment frictions in sectors and countries with a natural capacity to benefit. While subsidies may help countries capitalize on existing strengths, they are no silver bullet for creating new ones. As global subsidy spending accelerates, this evidence-based perspective offers an essential guidepost for future policy design.