Brexit, foreign investment & employment

By Prof. Nigel Driffield, Warwick Business School

Inward investment is of vital importance to the UK economy. Compared to other G7 countries, the UK has had the highest percentage of inward FDI as a percentage of GDP, at 64 per cent of GDP in 2014 (ONS 2016). Much of this investment is from other EU member states, as Figure1 shows.
 
How is inward investment likely to be affected by the UK leaving the European Union?
Investors in the UK will face a number of challenges as a result of Brexit if they seek to sell into the EU and operate supply chains that cross between the UK and the UK. The devaluation in sterling will also have an impact on inward investment decisions.
 
There will be challenges for investors if they seek to operate supply chains that cross (sometimes several times) between the UK and EU. When the single market was created in 1993, many commentators speculated that intra-EU FDI would plummet. This turned out to be far from the case as firms took advantage of the opportunities to coordinate resources across countries. The single market connects innovative firms to the richest market in the world and, through EU regional policy and structural funds, allows firms to take full advantage of location economies where labour is available in low-cost locations. Most recently, Honda has warned MPs of the consequences of leaving the customs union.
 
 
From an inward investment perspective the essential problem is that the ‘middle region’ of activities of the value chain, characterised by lower value added and higher volume of employment, are often carried out outside the UK. Developed countries attempt to “plug the gap in the middle” by seeking inward investment that will generate employment for the squeezed middle. This can be achieved by identifying key sectors that hit the ‘sweet spot’ of high productivity but also employment generation. However, these sectors, such as advanced manufacturing, food technology and financial services, are the ones most vulnerable to frictions in value chains which drive away investment, due to the way they are organised in the single market.

1. Develop an inward investment strategy through greater understanding of why firms seek to invest in the region. High value added FDI adds significantly to the underlying technological base of the economy, but creates fewer jobs, while FDI that generates large scale employment is typically (though not always) associated with less cutting edge technology. So our strategy needs to communicate which sectors will be able to attract inward investment of what type, and where this most likely to be sourced. This emphasises not ‘sectors’ as such, but value chains, where activity within the region is positioned within an international setting, and the vulnerabilities of value chains to global changes, or to macroeconomic factors such as exchange rate changes or changing terms of trade.
2. Focus inward investment efforts on sectors where free trade with the EU is less important. This means seeking to maximise the benefits of large scale investments in infrastructure (in the context of the Midlands, HS2); recognising the need for example to support skills in jobs around project management and professional services associated with infrastructure projects; and building robust supply chains to support infrastructure development.
3. Maximise the returns on inward investment. This again requires an understanding of the benefits of inward investment, for example of the benefits to supply chains or through knowledge transfer from inward investors into local firms. In order to understand how policy levers in this space can be applied, one has to understand the motivation and financing of FDI. For example, in the years prior to the financial crisis, a high proportion of global FDI was funded by debt, that has since not been available. One response therefore needs to seek FDI which is genuinely exogenous to the UK, that is, it is funded, not by loans financing raised from UK capital markets, but from the home country. This varies by country. Much Asian FDI for example is now funded by cash flow generated in the home country, compared with US, EU and Japanese investment which is typically debt financed. A country strategy is required therefore for investment promotion agencies as well as a sectoral strategy.
4. When selecting key sectors for inward investment, focus on job creation as well as value added One concern of the moment is that, in contrast to the 1980s/ 1990s when the focus was all of job numbers, there is a current obsession in policy circles with productivity. This means that some locations are focussing on what they can attract (including skilled workers) rather than focussing on how to create employment opportunities for the people in their region. This needs to focus on job quality however rather than just the number of jobs created.

Source: ONS 2016