WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

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By Mahdi Ghodsi

Using firm-level and patent data across EU regions, our project offers four major findings:

• Technological complementarity drives FDI location and asset growth
• Regulatory alignment attracts innovative FDI
• Innovation capacity amplifies the benefits of FDI
• Green FDI fosters sustainable innovation

Our new research reveals how the European Union (EU) can attract foreign direct investment (FDI) that has a strong positive impact on green innovation and regional development. Using firm-level and patent data, we show that innovation spill-overs from FDI are most effective when it aligns with regional technological strengths, regulatory compatibility and innovation capacity – particularly when it comes from firms that are intensively engaged in green technologies. These findings support a more targeted and strategic approach to FDI policy across Europe in technologies that the EU must develop (e.g. green technologies).

As the EU pursues climate neutrality and greater economic resilience, attracting FDI with a focus on innovation in well-defined areas (e.g. green technologies) can be an important catalyst to achieve these goals. Such FDI needs to be in line with regional technological strengths, support green innovation, and fit within a coherent regulatory framework.

When and where FDI works

1. Technological proximity matters

The results of the first paper, by Castelli et al. (2025), show that multinational enterprises (MNEs) tend to establish subsidiaries in regions that are specialised in complementary technologies rather than in those matching the parent firm’s core specialisations. Specifically, when a parent MNE is strong in certain technologies (e.g. green technologies), it often avoids locating subsidiaries in similarly specialised regions. Further, our results indicate that subsidiaries innovating in green technologies tend to increase their assets in EU regions specialised in such technologies. This suggests that FDI does not flow randomly into ‘catch-up’ regions, but that multinationals target areas with existing technological strengths, thereby enhancing local spill-overs to the MNE and fostering more effective subsidiary development.

2. Regulatory compatibility and institutional design are crucial

Our analysis shows that regulatory distance (RD) – meaning the difference between the rules and standards in the home and host countries – significantly affects the volume of FDI. When non-tariff measures (NTMs) – such as product standards and environmental regulations – differ substantially between countries, firms face higher entry costs and greater uncertainty about compliance. Reducing these differences by harmonising NTMs, both within the EU’s single market and with key external partners, could lower barriers to entry and attract more innovative forms of FDI.

3. FDI is more beneficial in places where domestic firms innovate

The second paper, by Davies et al. (2025), finds heterogenous effects of FDI – based on different measurement approaches – on domestic firms’ employment and productivity. First, the most significant benefits from horizontal FDI (i.e. when multinationals operate in the same sector as domestic firms) arise when local firms are patenting and able to absorb, adapt and upgrade in response to the technologies and practices introduced by MNEs. By contrast, domestic firms that do not engage in innovation tend to derive little or no benefit in terms of employment or productivity from horizontal, innovation-driven FDI.

Second, when FDI takes place in sectors supplying intermediate inputs to domestic firms, the spill-over effects are consistently positive, even for non-innovating domestic firms. For instance, consider a domestic firm operating in the automotive sector: the presence of FDI in upstream areas of the automotive sector (e.g. electronic components, chipsets and metal industries) can enhance the domestic firm’s productivity and employment. Third, in contrast, FDI in downstream sectors (e.g. many services and manufacturing including retail, wholesale and transportation) is associated with lower employment in the domestic firms, irrespective of the innovative capacities of the latter.

However, this pattern changes with the innovative activities of MNEs: if the FDI subsidiary in the downstream sector is innovative, it may lead to higher employment in the domestic firm. Likewise, innovation by the foreign parent company of such a subsidiary in the downstream sector may contribute to higher productivity in the domestic firms upstream of these subsidiaries. These patterns hold for green patenting, too.

4. Green FDI supports green industries, while non-green FDI may undermine them

The third paper, by Micocci et al. (2025), analyses the FDI spill-overs to domestic firms’ patenting activities. Innovation from foreign-owned subsidiaries does not significantly spill over to domestic firms’ patenting activities. As noted above when discussing the first paper, one important factor behind increased total assets of foreign-owned subsidiaries is that the intellectual property spill-overs often flow in the opposite direction – from domestic firms to subsidiaries of MNEs. However, the results of the third paper suggests that, for various reasons, MNE parent companies typically seek to protect their intellectual property within their ownership networks, often by investing in regions that do not closely resemble their own technological profile. However, their knowledge and technologies can still spill over, such that patenting activities of domestic firms in the regions where their subsidiaries operate would increase.

Investments by parent firms intensively engaged in green technology are associated with stronger local performance in green innovation, as evidenced by increased patent filings. Conversely, MNEs that are not focused on green technologies may dilute – or even displace – the sustainability orientation of local innovation ecosystems.

The role of regional innovation ecosystems

These findings suggest that FDI is not a magic bullet. Its impact depends heavily on the domestic context – especially the availability of human capital and skilled labour, infrastructure, and innovation networks. This implies a twin-track policy agenda:

1. Support absorptive capacity in regions that are lagging behind through public R&D, skills training and cluster development. For instance, enhancing R&D and patenting activities in less developed regions (e.g. through tax credits and targeted funding) can strengthen their ability to absorb and benefit from the spill-overs of innovative FDI.
2. Target facilitation efforts towards regions and sectors where FDI can be catalytic rather than merely extractive. For instance, if a region seeks to develop specific green technologies, it should incentivise foreign MNE parent companies that specialise in those areas. As shown in the empirical results, the key is to promote technologies in which the region is already specialised and which the MNE aims to acquire and develop know-how related to this specialisation through its subsidiary. While the parent MNE benefits from accessing and developing new technological capabilities, the region gains from the spill-overs of the parent’s expertise and innovation.

EU cohesion funds, industrial alliances and national recovery plans should be leveraged in this direction. The aim is to ensure that even less developed regions become attractive – not just for any FDI, but for the right kind of FDI.

Competing in a multipolar investment landscape

Europe’s investment attractiveness cannot be taken for granted. The advancement of green technologies in the US and China – combined with substantial public support for frontrunners in these fields – has already fuelled a rise in techno-industrial competition that could reshape the global FDI landscape. Given these circumstances, now more than ever, the EU’s ability to compete needs to provide a guided path to industrial development. Effective investment promotion must be sector-specific, long-term and grounded in Europe’s comparative advantages in some areas of green technology (e.g. wind energy, heat pumps and geothermal energy), advanced manufacturing and high-quality governance. The EU should also lead by example in international rulemaking, such as by championing the harmonisation of standards and the mutual recognition of regulations. These practices, long embedded in the European single market, promote sustainability and transparency in cross-border investment.

Conclusion: From quantity to quality

These patterns raise important strategic questions for EU policy. If FDI reinforces pre-existing innovation hubs, how can less developed regions catch up? And since not all FDI is green, what safeguards can ensure alignment with the EU’s climate goals?

As outlined in the policy note by Castelli et al. (2025), FDI can be a powerful driver of innovation and green growth – particularly if strategically guided. Traditional factors (e.g. political, institutional and economic stability) already attract high volumes of FDI to the EU. Yet Europe’s challenge lies in moving beyond a blanket policy towards a more nuanced and strategic approach.

This means prioritising technological and environmental compatibility; fine-tuning FDI screening mechanisms with sustainability goals that protect not only strategic autonomy and national security, but also innovative and green FDI; strengthening local ecosystems to absorb and benefit from foreign knowledge; and ensuring that green FDI reaches not only already advanced regions but also those at risk of falling behind.

We propose that investment agreements and screening mechanisms integrate a ‘green filter’, meaning one that gives priority to investments aligned with EU climate goals while simultaneously discouraging those that risk locking regions into carbon-intensive development paths. Such an approach could be complemented by positive facilitation (e.g. expedited approvals, infrastructure support or R&D co-financing) for green and innovative MNEs. Importantly, this does not require dismantling the EU’s current investment openness. Rather, it suggests recalibrating openness towards long-term strategic value.

Moreover, the presence of coordinated innovation and competition policies, along with functional intellectual property regimes, amplifies the benefits of incoming FDI. Without these, technology transfers remain limited, and FDI may become extractive rather than developmental.

Given limited budgets and fiscal constraints, general subsidies for all kinds of FDI should be avoided. However, targeted instruments (e.g. so-called ‘patent boxes’ focused on specific technologies) can provide directional incentives for innovative FDI, leveraging the intellectual property held by foreign parent MNEs. A patent box is a special very low corporate tax regime to incentivise research and development by taxing patent revenues much lower than other commercial revenues. At present, 13 EU member states (i.e. Belgium, Cyprus, France, Hungary, Ireland, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Slovakia and Spain) maintain patent-box regimes. Rather than being part of an EU-wide policy, these patent boxes are based on individual national decisions.

In short, the future of Europe’s green transformation depends not merely on whether investment arrives, but on what kind of investment it is.

 

References

Castelli, C., Davies, R. B., Mendoza, J. F. & Ghodsi, M. (2025). Drivers of FDI in the EU: Regulatory distance and revealed technological advantage. wiiw Working Paper No. 264. The Vienna Institute for International Economic Studies (wiiw), June.

Castelli, C., Davies, R. B., Mendoza, J. F., Ghodsi, M., Guadagno, F., Micocci, F. & Rungi, A. (2025). Harnessing FDI for innovation and green growth in the EU: Some evidence-based policy recommendations. wiiw Policy Notes and Reports No. 97. The Vienna Institute for International Economic Studies (wiiw), June.

Davies, R. B., Ghodsi, M. & Guadagno, F. (2025). Innovation interactions: Multinational spillovers and local absorptive capacity. wiiw working Paper No. 265. The Vienna Institute for International Economic Studies (wiiw), June.

Micocci, F., Ghodsi, M. & Rungi, A. (2025). FDI and innovation dynamics: The role of foreign corporate groups and technological pathways in domestic green innovation. wiiw working Paper No. 266. The Vienna Institute for International Economic Studies (wiiw), June.