The restrictions imposed on the inflows of people and goods into the US have ushered in a new era of economic nationalism. It’s unlikely that these trends will reverse even after President Trump demits office.
Amidst this new wave of economic nationalism, it is only a matter of time before capital flows become the focus of attention and attract restrictions. This is already evident in President Trump’s policies that mandate foreign countries to make massive investment commitments in the US and directives to US multinationals to invest in the US. It’s only a small step to force US companies to restrict investments outside. Don’t be surprised if one of the high-profile investment commitments abroad by a US company triggers resentment and policy measures in this direction. Capital controls may well be the next big Trump policy action.
This comes on top of growing restrictions on capital flows due to national security and strategic reasons, on the back of rising geopolitical tensions. US outbound investments in critical technologies like AI, quantum, and semiconductors are being subjected to scrutiny and permissions. The US, for example, tightly controls outbound sales of the latest Nvidia chips (and associated investments) that are a major part of the data centre boom.
This is not a US phenomenon. The general reversal in the trend of offshoring will invariably reduce investments in developing countries. In addition, there are already signs of countries questioning the trend of their pension funds lowering domestic exposure while chasing returns outside.
The Canadian Industry Minister, Melanie Joly, has called on its C$3tn (US$2.1tn) pension system to boost domestic investment as it seeks C$500bn in new finance to reboot the economy and lower its dependence on the US.
The Canada Pension Plan Investment Board, the country’s largest fund with C$714bn of assets, revealed its total allocation to Canadian assets dropped to 12 per cent of the fund in March from 14 per cent two years earlier, although the total value of Canadian assets still increased… Last year more than 90 Canadian corporate executives signed an open letter calling on the government to amend rules which would allow them to increase domestic investments, saying the amount they allocated to Canadian equities had dwindled from 28 per cent in 2000 to 4 per cent by 2023. Ottawa in December lifted its 30 per cent cap for investments in Canadian entities at a time when Trump was threatening tariffs and trade wars against its major trading partner… CPP Investments has nearly 50 per cent of all its assets invested in the US, despite pressure from Ottawa to invest more in its home market. Similarly Omers, the pension fund for Ontarian municipal workers with C$141bn of assets, had 16 per cent invested in Canada and 55 per cent invested in the US at the end of June.
A similar trend is emerging in the UK for raising domestic equity allocations for British pension funds.
Targets of 5 per cent, 8 per cent and 10 per cent were discussed as reasonable thresholds to consider, and there was broad agreement that defined contribution schemes should be prioritised over defined benefit schemes… Pension funds are expected this month to sign a voluntary compact — an update of the 2023 Mansion House compact signed under the last Conservative government — to invest 10 per cent in private assets by the end of the decade, with half of that in the UK.
Chancellor Rachel Reeves has announced that she will create a “backstop” power to compel investment in British assets if voluntary efforts fall short.
She vowed to unleash more than £50bn of investment in domestic infrastructure, housing and fast-growing businesses. The highly contentious move towards “mandation”… will feature in new pensions legislation later in the year. The chancellor hopes creating pension “megafunds” with more than £25bn in assets, coupled with a voluntary accord with industry to boost allocations to private assets, will reverse long-term falls in investment in the UK… It is the first time the Treasury has publicly confirmed it will legislate to create a backstop power to mandate pension funds on their investment strategy.
In both countries and elsewhere, there are growing pressures on pension funds to reduce foreign exposures and mandate higher domestic investment requirements. Australia’s National Reconstruction Fund and other infrastructure initiatives incentivise, in various forms, domestic institutional funds to direct capital into domestic projects. France and several other EU members have similar incentives and regulatory frameworks to direct insurance and pension funds into domestic projects, and these trends are on the rise.
Given the massive infrastructure replenishment requirements across developed countries, there will be increased pressure on long-term funds to prioritise domestic deployments of capital. The already small share of long-term capital—institutional funds and private equity—flowing to infrastructure in developing countries will decrease further.
This trend in finance squares with the broader shift towards protectionism elsewhere. There’s nothing about economic nationalism that ought to confine it to only goods and services, and people. Capital will inevitably join the list. Given these trends, we may well be at peak global financial integration, too.
An IMF paper from 2024 finds empirical evidence indicating that capital controls on outflows (CCOs) are associated with crises and declines in GDP growth. Given the emerging situation of macroeconomic and financial distress in many developed economies, the likelihood of the implementation of CCOs is growing stronger.
In the circumstances, developing countries like India should be prepared for a reduced flow of foreign direct investments (FDI). This is more likely to be pronounced in technology areas. While financial markets will always pursue returns, domestic political economy factors are likely to hold back outflows of long-term capital like pension funds and insurers.
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