Risk or opportunity? USA–China tensions and the shift in foreign direct investment patterns

Abstract

This study aims to examine how changes in USA–China tensions (UCTs) are associated with aggregate inward foreign direct investment (FDI) in the USA and China. It also distinguishes the directly observed investment risk from possible adaptive opportunities created through relocation, diversification and alternative market-entry strategies. The study uses panel data over 1993–2023 and establishes the regression by using the Cross-Sectionally Augmented Autoregressive Distributed Lag (CS-ARDL) model and Fully Modified Ordinary Least Squares (FMOLS) models. A geopolitical tension index, capturing trade disputes, sanctions and diplomatic frictions, is incorporated alongside relevant macroeconomic controls to ensure robustness. The dual-method approach allows for consistent inference under potential endogeneity and cross-sectional dependence. The empirical results from both CS-ARDL and FMOLS are consistent and reveal a significant negative association between UCTs and FDI inflows in both the short and long run. Heightened geopolitical uncertainty weakens investor confidence, while trade restrictions, tariffs and sanctions further discourage cross-border investment between the two economies. The dependent variable is aggregate inward FDI for each country rather than origin-destination bilateral flows. The analysis therefore cannot separately estimate US investment in China and Chinese investment in the USA. For policymakers, the results highlight the importance of diplomatic stabilization and predictable trade policies to sustain international investment flows. For investors and multinational firms, the study underscores the need to integrate geopolitical risk into strategic location and diversification decisions. Governments seeking to attract diverted FDI can benefit by improving institutional quality and reducing policy uncertainty. This study contributes to the literature by providing a long-horizon (1993–2023) empirical assessment of geopolitical tensions and FDI using a robust dual-method strategy (CS-ARDL and FMOLS). It offers new evidence on how sustained USA–China frictions structurally alter bilateral investment behavior, positioning geopolitical risk as a central factor in global FDI reallocation.