Connecting FDI and SMEs for Productivity and Innovation in Europe

Executive summary

For decades, multinational enterprises (MNEs) have been integral to Europe’s productive fabric, supporting jobs, innovation, and regional growth. The EU-27 now hosts a foreign direct investment (FDI) stock of about USD 12.4 trillion – accounting for over one-third and one-quarter of the OECD and global totals, respectively – reflecting deep integration with global capital. Yet FDI has become increasingly volatile, shaped by successive shocks from the pandemic, Russia's war of aggression against Ukraine, and rising trade tensions. These shocks have coincided with a structural shift in FDI towards fast-growing digital and green industries, creating both opportunities and challenges for small and medium size enterprises (SMEs) seeking to connect with MNEs. Drawing on rich subnational data and firm-level evidence, the report provides insights into where FDI-SME linkages emerge, how they influence productivity and innovation, and what policy actions can help spread these benefits more widely across the EU.

Europe’s uneven FDI landscape is being reshaped by the green and digital transitions, bringing both challenges and opportunities

Foreign investment is far from evenly shared across Europe’s regions and recent disruptions have reinforced long-standing disparities. A handful of urban hubs capture the majority of capital, while many regions attract little or none. Regional disparities in FDI are also more than three times that of GDP. About two-thirds of this disparity lies within rather than between Member States, driven by dynamic capital-city and metropolitan regions pulling ahead of their domestic peripheries. These divides are also persistent: since 2003, around 85% of regions have remained in the same position – whether among the biggest winners or those receiving the least investment – with only limited upward mobility even during periods of rapid expansion. This “winner-takes-most” geography leaves large parts of Europe with limited access to the opportunities FDI can bring, although some regions can still benefit indirectly through supply chain linkages with MNEs.

At the same time, the rapid shift in investment towards Europe’s green and digital transitions are redefining sectoral patterns and partnership opportunities. Digital activities now account for over one-third of total inflows, becoming the largest destination for new projects, while clean energy has almost doubled its share to around 20% in 2023–2024. These sectors are creating new opportunities for collaboration between foreign and domestic firms but also changing the nature of FDI–SME linkages, which increasingly depend on innovation capacity and technological readiness. Conventional manufacturing corridors have lost ground overall yet remain important, with strong clusters persisting across parts of France and central and eastern Europe.

Lasting foreign investment presence is closely linked to strong regional skills, innovation systems, connectivity, and SME ecosystems

Some regions in Europe turn foreign investment into long-term growth, while others see projects remain isolated or even displace weaker domestic firms – a process that can also reflect healthy market reallocation. The difference lies in how local conditions interact. A skilled workforce, vibrant innovation systems, and reliable transport links are each important, but together they create stronger ecosystems that attract higher-value projects and help them remain embedded rather than relocate when costs or strategies shift. This interplay is captured by a readiness index developed in the report, which measures the combined strength of skills, innovation, and connectivity, and groups EU regions into four categories of FDI readiness – Leaders, Emerging, Untapped, and Lagging. Several Central and Eastern European regions who have strengthened all three dimensions recorded above-average FDI growth.

Within local ecosystems, the characteristics of SMEs determines how deeply investment becomes embedded in the local economy. SMEs account for 99% of EU firms, but their capacity to connect with MNEs varies widely. Enterprise density ranges from under 20 to over 200 firms per 1,000 inhabitants, while productivity spans an 18-fold gap. In the strongest ecosystems, around 21% of firms operate in medium- and high-tech manufacturing or knowledge-intensive services, compared with just 15% in the weakest. Regions where SMEs are both more productive and more concentrated in these sectors are far more likely to develop supplier linkages and absorb new technologies. FDI also tends to flow to sectors where domestic firms are already active, suggesting that alignment between FDI and local industrial structures can facilitate linkages through shared labour pools, supply chains and knowledge networks.

FDI is associated with productivity gains for SMEs, particularly in less developed regions that attract investment

When foreign investors settle in EU regions with skilled workers, vibrant innovation systems and solid infrastructure – and where local SMEs can connect – one payoff observed is higher productivity rather than stronger employment growth. Firm-level analysis of more than 24,000 companies in Germany, Italy and Romania shows that regions attracting more FDI host more productive SMEs, while large firms see little additional boost. This likely reflects the smaller technology gap between MNEs and big domestic firms, and the greater scope for SMEs to upgrade when exposed to demanding buyers and new practices.

How investment embeds locally also matters for the type and scale of benefits that domestic firms experience. When foreign buyers purchase from local suppliers, productivity gains among SMEs tend to be strongest and most consistent. Foreign investment in the same industries as domestic firms produces smaller gains and can intensify competition, prompting weaker firms to adapt or exit. By contrast, when foreign investors enter industries that supply inputs to domestic firms, productivity effects are limited and, at best, accompanied by weak employment gains among the smallest or largest firms.

Sectoral and regional development patterns further influence FDI outcomes. Productivity spillovers are most visible in industrial SMEs, where integration into value chains helps diffuse technology and improve processes. Service-sector SMEs show weaker effects, as many activities are fragmented or less tradable, limiting sustained links with foreign investors. Although less developed regions – characterised by weaker skills and less diversified economies – attract less FDI overall, firms located there often experience greater productivity gains when investment does occur, as foreign investors provide access to knowledge, markets and international networks otherwise out of reach.

The three countries analysed illustrate this diversity of experience. Italy shows the broadest productivity improvements, with many SMEs benefiting when foreign investors enter their supply chains. Germany displays fewer and more selective gains: SMEs record some positive effects in their own sectors but face competitive pressures when foreign investors enter their input-supplying industries, where markets are already highly efficient. Romania records only small and uncertain benefits, reflecting the limited integration of domestic firms with foreign investors.

Targeted policies can steer investment towards more regions and help local firms capture greater value from it

While FDI can enhance SME productivity with the right local conditions in place, such conditions are uneven across regions and spillovers are far from automatic. MNEs rarely embed deeply without deliberate effort, and many SMEs lack the scale, technology or management capacity to serve demanding global buyers. Without targeted policy action, investment may benefit only a few firms while leaving most untouched or displaced by stronger competition. This may be particularly relevant in less advanced EU regions, where productivity gains could be greatest when FDI does connect. Success is more likely where core enablers – skills, innovation and infrastructure – are strengthened, and local industries are aligned with high-spillover sectors such as medium- and high-tech manufacturing and knowledge-intensive services.

A place-based approach could help regions turn investment inflows into longer-term productivity gains. Regions that combine investment attraction with aftercare, supplier upgrading and skills development tend to retain investors and build deeper local linkages. Useful tools include FDI-SME matchmaking platforms that connect capable SMEs with investor needs and targeted upgrading support to SMEs, particularly in fast-growing green and digital value chains. Embedding these measures in national and regional investment promotion strategies – aligned with EU Cohesion Policy priorities and the EU’s green and digital objectives – could help build ecosystems that anchor foreign investors in local value chains and innovation networks. Further evidence is still needed on which policies most effectively translate FDI into SME productivity gains. Richer subnational data, better tracking of supplier participation and more robust evaluation frameworks would help governments identify what works under different regional conditions and how investment can contribute to both regional cohesion and Europe’s twin transitions.