What are the potential implications of independent Scotland for inward foreign direct investment?

by Stephen Young, Duncan Ross, Brad MacKay, Veselina Stoyanova

Previous and Current trends in Scotland’s Inward Foreign Direct Investment

Since the middle of the last century, Scotland has been an attractive destination for market-seeking foreign direct investments (FDIs) in manufacturing industry, mostly coming from the United States. Contributing factors for this trend have undoubtedly been the relatively good access to low cost labour, the use of English as a working language as well as the financial assistance made available to companies  as a primary governmental incentive.

However, the changing political and business milieu in Eastern Europe in the 1990s  helped to highlight the fact that foreign direct investment by footloose foreign firms can be fickle. This can be particularly the case when FDI is “competency” rather than “resource” exploiting, which has been largely the case in Scotland. The rise and fall of the electronics industry through the 1980s and 1990s in Scotland is a case in point.

The FDI landscape in Scotland today has changed significantly, although it is still very prominent. Whereas  in the past the manufacturing sector accounted for the highest concentration of FDI, today competency creating/exploiting FDI  centres on projects in sectors such as oil & gas and renewables, business services and software, machinery and food and drink.

Generally investment from foreign-owned MNEs is of high significance for both employment and research and development in Scotland. The total of 745 FDI projects for the period 2003-2012 generated about 76,000 new jobs in Scotland, the principal job-creating sectors being food, drink and tobacco. This placed Scotland second in terms of FDI project attraction after only London and the South-East regions in the UK. Overall, inward FDI characteristics indicate that Scotland is not only an attractive but also frequently preferred place for foreign investments.

Persisting challenges coming into the Scottish referendum

However, besides the overall attractiveness of Scotland for inward FDI and the importance of foreign-owned MNEs in the country’s employment and research and development, a number of challenges still need to be addressed in the pre-referendum period. A key issue is found in the performance of Scotland’s indigenous private sector, and more specifically, in the ability of Scotland’s indigenous firms to absorb knowledge and technology from FDI, which is critical if the domestic economy is to benefit from the “spill-over effects” of FDI. Scotland still lags in terms of its overall sectoral innovativeness measured through trends in entrepreneurship, business birth rates, R&D and innovation activities.

In terms of the country’s entrepreneurial spirit, the age of people anticipating starting a business is well below the UK average. In regards to business birth rates for the year 2012, Scotland is ranked 8th among the UK’s 12 regions. Scotland also lags behind the UK overall in regard to its proportion of innovation-active firms (about 33% of firms in Scotland compared with the UK average of 37% by some estimates) in 2011 (Turnbull and Richmond, 2013). Similar trends are evident in terms of the country’s R&D, which is  dominated by foreign-owned MNEs. Such challenges will continue to exist in the period after the Scottish referendum on independence – whether it is a ‘yes’ or a ‘no’ vote in September.

A ‘Yes’ vote and its implications on inward FDI flows: Challenges and Opportunities

Since 1945, the attraction of FDI has been an important policy instrument for the UK government. It has played an even more significant role in the Scottish political spectrum, reflecting the significance of inward FDI for the Scottish economy. However, the potential drawbacks of the referendum debate on inward FDI attraction should not be neglected. Undoubtedly, one potential challenge is the management of the political uncertainty which foreign as well as domestic investors will face. A second issue would be what scholars of international business call the “liability of foreignness” if Scotland becomes independent.

In the transition period following a ‘yes’ vote there will be significant uncertainty over and above the ‘normal’ uncertainty of changing governments in democratic countries. Such uncertainty will heighten the risk profile of Scotland for foreign investors whose market scope includes the rUK, either as exporters or firms which implement pan-UK supply/value chains. Indeed, we have already observed evidence of this indirectly as the independence referendum has migrated up the ‘risk registers’ of domestic firms in recent months. If Scotland becomes seen as a ‘riskier’ place to invest because of heightened political uncertainty, FDI flows will almost certainly be negatively affected in such industries as energy, banking and financial services and defence.

Moreover, it can be anticipated that those MNEs that have subsidiaries within a Scottish jurisdiction, particularly if they are competing for corporate-wide resources with subsidiaries in other countries and regions, will be most affected by political uncertainty. Such political uncertainty - whether it is over currency, continuing membership in the EU, trade agreements with other countries, the regulation of industries, taxation, pensions and/or an accumulation of all of these risks - may lead MNEs  to  defer investment in Scotland, or direct it to other countries/regions.

Of course, a ‘yes’ vote in the September 18th, 2014 referendum also presents certain opportunities following the “transition period” (the period of uncertainty that would accompany negotiations), though a number of challenges would still have a dampening effect on them. One such opportunity is the possibility for a better tailoring of policy measures to Scottish needs, and also the potential growth of Edinburgh as an independent capital and headquarters base for a number of multinational companies, albeit in a much smaller market. A reduction in corporate taxation might also have short-term benefits, although such measures often attract transient FDI of the competency-exploiting kind, rather than the more beneficial longer-term competency-creating sort. Reductions in corporate tax might also create a ‘race-to-the-bottom’ if matched by the rUK, which would reduce tax revenues for government coffers.

Another business opportunity in the event of a ‘yes’ vote in the referendum could potentially be the enhancement of ‘Brand Scotland’, which may result in further FDI attraction. Of course, uncertainty created by an independence vote, and/or any deterioration in the fiscal health of the Scottish economy or friendliness towards business investment in Scotland as a result of independence could also tarnish ‘Brand Scotland’, rather than enhance it.  It is also clear that business opportunities are accruing from the recent initiative of the Scottish government to boost renewable technologies as a mechanism for reindustrialization. Such initiatives taken by the Scottish government, however, will be dependent in part on wider UK energy policy, and FDI flows in this area may well be sensitive to any changes to the highly integrated UK energy market that come as a result of different policy choices taken by the UK government.

Note: This blog is adapted from the following forthcoming paper: Young, S., Ross, D., & MacKay, B. (2014). Multinational Business Review. 22/2. 

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Brad MacKay's picture
post by Brad MacKay
University of St Andrews
26th May 2014
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