The "Great Divergence" of Global Capital Flows to Emerging Markets: The Decoupling Puzzle of China and the Rest of Emerging Markets
International capital is redrawing the investment landscape of emerging markets. A recent study by the Brookings Institution, based on balance-of-payments data from 25 large emerging market economies, points to a significant "decoupling" between China and other emerging markets in terms of capital inflows. This decoupling is not the result of a single event, but rather the cumulative outcome of long-term trends, geopolitical shocks, and policy cycles. Understanding the internal structure of this divergence holds strategic value far beyond short-term market fluctuations for multinational corporations'布局, sovereign wealth fund allocation, and emerging market policymakers.
I. From "Capital Gravity Field" to "Divergence": A Data Fact
In the decade before the pandemic, China was a super magnet for global capital flows: whether foreign direct investment (FDI), portfolio investment, or other investment mediated by banks, all showed sustained and robust net inflows. However, after the pandemic, this picture underwent a fundamental reversal.
Robin Brooks, a senior fellow at the Brookings Institution, decomposes capital flows into three categories: real FDI excluding reinvested earnings, portfolio investment in equities and bonds, and "other investment" covering trade credit and cross-border loans. Measured by the four-quarter moving average as a share of GDP, China and the remaining 24 emerging markets (EM) show a clear divergence.
Most striking are portfolio investment and other investment: the former has shown persistent net outflows in China, while in other emerging markets it stands at the stronger end of its historical range; the latter weakened significantly after the pandemic and deteriorated further after geopolitical conflicts. Even in the FDI sector, although China still records positive inflows, the gap relative to GDP with the rest of emerging markets is narrowing, and is even forming a trend-based divergence.
II. Three Kinds of Capital, Three Timelines: The Fine-Grained Nature of Decoupling
The "decoupling" of capital flows is not monolithic. Different categories of capital correspond to different investor types, risk appetites, and decision cycles, and their drivers therefore differ accordingly.
**1. Foreign Direct Investment: A Microcosm of Long-Term Structural Decline**
Excluding reinvested earnings, the weakening of China's FDI inflows is not an abrupt shock but a long-term trend spanning many years. Behind this lie rising labor costs, intensifying domestic market competition, overcapacity in some industries, and the continued penetration of global supply chain localization and "friend-shoring" strategies. Multinational corporations no longer view China simply as the "world's factory," but instead weigh more carefully the relative position of China's market, production, and innovation networks.
It is worth noting that over the same period, FDI in other emerging markets did not experience a comparable decline, and even remained resilient in certain industries. This suggests that global direct investment is shifting from an "efficiency-first" approach to a multidimensional assessment that values both "security and resilience," and that China faces more pronounced structural challenges in this transition than other EMs.**2. Portfolio Investment: Repricing of Policy Cycles and Risk Premiums**
The divergence between China and the rest of the EM in portfolio investment—both equities and bonds—appears to coincide chronologically with the start of a new U.S. administration. This is no coincidence. U.S. policy shifts often trigger a global repricing of risk appetite, especially expectations around tariffs, technology controls, and capital flows. When international investors assess Chinese assets, they no longer focus solely on growth data; they also factor in geopolitical premiums, policy predictability, and the pace of capital account liberalization.
In contrast, other emerging markets have benefited from risk-diversification demand, attracting relatively incremental capital attention in global allocations. Of course, this "substitution effect" is not a zero-sum game, but rather a byproduct of global portfolio rebalancing.
**3. Other Investment: The Chain Reaction of Geopolitical Conflict and Trade Finance**
The sharp weakening of "other investment" is highly correlated with post-pandemic global supply chain disruptions and events such as Russia's invasion of Ukraine. This type of capital relies heavily on interbank credit lines, trade letters of credit, and short-term interbank lending, making it most sensitive to geopolitical and sanctions risks. After the Russia-Ukraine war, cross-border banking systems comprehensively tightened their exposure reviews of specific countries, and sanctions-compliance requirements related to Russia spilled over to a broader range of emerging markets—China was not spared either.
In addition, fluctuations in the RMB exchange rate and changing expectations regarding capital controls have, to some extent, dampened enthusiasm for trade finance. Overall, the sluggishness of other investment reflects the rising prudence of global financial institutions regarding their balance sheets amid geopolitical uncertainty.
III. The Global Industrial Logic of Capital Diversion
Capital decoupling is not confined to the financial account itself; it mirrors the restructuring of the global real economy. In recent years, global supply chains have exhibited a compound evolution characterized by "regionalization + nearshoring + diversification." While maintaining their market share in China, multinational corporations have accelerated the construction of secondary supply nodes in Southeast Asia, South Asia, Mexico, and other regions. The supply chain maps of key industries—semiconductors, new energy, pharmaceuticals—are being redrawn, and FDI flows are consequently being reshaped.
This process is not simply "de-Sinicization"; it is a rebalancing by firms between efficiency and security. China still possesses a vast domestic market, well-developed industrial supporting systems, and a rapidly iterating engineering talent dividend, but the marginal driver for attracting foreign investment has shifted from "low-cost manufacturing" to "indigenous innovation + high-end manufacturing." Meanwhile, other emerging markets, leveraging labor costs, locational advantages, or free trade agreement networks, have absorbed part of the relocated production capacity and thereby gained new capital inflows.
From a broader macro perspective, emerging economies of the Global South are becoming important destinations for the diversified allocation of international capital. Whether it is India, Indonesia, Mexico, or Saudi Arabia, all are attracting long-term capital through narratives such as infrastructure investment, the digital economy, and green transition. The "great divergence" of capital flows precisely reflects this multipolar investment landscape.
IV. Implications for Investment Decisions and PolicymakersFor multinational corporations, the capital divergence between China and other EMs means that country risk and return frameworks must be re-examined. China's long-term growth potential still exists, but its foreign investment policies, regulatory environment, and geopolitical risks must be incorporated into more complex models. At the same time, enterprises need to avoid equating "diversification" with "withdrawing from China," and instead build more resilient regional portfolios so that China and other Asian supply chain nodes complement rather than substitute each other.
For emerging market policymakers, the resilience of capital flows is not innate. A stable legal environment, predictable policies, deepened financial marketization, and outward-oriented infrastructure are key to attracting long-term capital. Economies that can provide transparent rules and stable returns will gain a larger share in the Great Divergence.
For international investors, the Brookings research reminds us: the drivers of capital flows vary with cycles. Short-term portfolio investment fluctuations should not be misread as structural FDI trends, nor should the impact of geopolitical events on high-frequency capital flows be underestimated. A detailed decomposition based on the balance of payments helps identify truly sustainable capital trends.
V. Conclusion: Seeking a New Equilibrium amid Uncertainty
The decoupling of global capital flows to China and other emerging markets is a complex phenomenon with multiple causes and effects. It is both a manifestation of long-term structural changes and a reflection of short-term geopolitical shocks. Going forward, as the global monetary environment shifts, geopolitical conflicts evolve, and national industrial policies advance, capital flows will continue to fluctuate. But what is certain is that global capital allocation has entered a new era that is more selective, more regionally sensitive, and more strategically flexible.
For observers, tracking the "granularity" of capital flows matters more than chasing aggregate figures. The divergent paths of FDI, portfolio investment, and other investment provide key clues for understanding the deep transformation of the global economic landscape. The eventual outcome of this "Great Divergence" will depend on the institutional competitiveness and geo-economic wisdom of countries in the new stage of globalization.