ECB | Working Paper Series: The protectionist gamble: How tariffs shape greenfield foreign direct investment

Abstract:

Motivated by current events, this paper assesses the impact of tariff increases on bilateral greenfield foreign direct investment (FDI) over the period 2016-2023. Leveraging a comprehensive dataset of announced greenfield investment projects, official FDI statistics, and bilateral product-level tariff data, we estimate a series of gravity equations to uncover key relationships. Our results show that, at an aggregate level, tariff increases are associated with a rise in greenfield FDI, consistent with the tariff-jumping hypothesis. However, this positive effect reverses for greenfield manufacturing FDI, where high-intensity tariff increases significantly deter investment. A sectoral analysis reveals substantial heterogeneity: consumer-facing industries tend to attract more investment following tariff hikes, while input-intensive sectors experience declines. Overall, our findings suggest that using tariffs to stimulate foreign manufacturing investment is a risky strategy.

Non-technical summary:

In recent years, tariffs have re-emerged as a prominent policy tool in global trade debates. Governments are increasingly using trade barriers not only for protection, but also to encourage companies to invest domestically. A notable example is the 2025 announcement by US President Trump of high import tariffs, explicitly framed as a way to attract foreign direct investment (FDI) into the United States. This raises important questions about how tariffs affect FDI, a major channel for international capital flows, knowledge transfer, and productivity gains.

This paper explores whether and how increases in tariffs influence greenfield FDI, defined as new investment projects that create productive capacity in the host country. While standard trade theory suggests that tariffs are harmful to growth, welfare, and prices, their impact on FDI is less clear. In some cases, firms may respond to tariffs by shifting production into the protected market, a phenomenon known as “tariff-jumping”. In other cases, especially for firms that rely on cross-border supply chains, tariffs may discourage investment by raising production costs.

For our analysis we use a gravity framework, commonly used in studies investigating the drivers of FDI, to assess the relationship between tariffs and greenfield FDI over the period 20162023. Tariff data are sourced from the Global Trade Alert (GTA) database, while greenfield FDI data are drawn from the fDi Markets database, which records announced greenfield investment projects, as well as from official FDI statistics. We also distinguish between all FDI projects and those in manufacturing, and examine sector-specific effects.

Our findings show that, overall, tariff increases are associated with a rise in greenfield FDI, supporting the idea that firms respond to trade barriers by investing in the tariff-increasing country. However, when focusing on manufacturing projects, which are a key concern for policymakers, the effect turns negative for tariff increases that target a large number of products. Moreover, the impact varies across manufacturing sectors.

Our results suggest that while tariffs may appear to stimulate foreign investment in some areas, they can discourage it in others, particularly in manufacturing. The “protectionist gamble” is unlikely to succeed if broad-based tariff increases backfire, driving up supply-chain costs and deterring investment.

See full paper here.

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