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#EURef - How might inward investment to be affected by Brexit?

Published: 8 June 2016
Author: David Eiser

How might inward investment to be affected by Brexit? - David EiserWhat is inward investment?

Inward investment (sometimes called inward Foreign Direct Investment) refers to the overseas operations of a multinational. Inward investment can include the establishment of foreign branches and subsidiaries, and the acquisition of foreign firms.

Inward investment is often seen as a good thing. Most obviously, it creates (or sometimes safeguards) jobs and raises incomes in the recipient country. It may also raise productivity in the recipient country, by introducing new technologies and working practices. But sometimes, inward investment may have more limited benefits. Acquisitions may result in profits being expatriated overseas. And there have recently been some high profile cases of inward investing companies which make fairly minimal corporate tax contributions to the governments of the countries that they invest in.

How important is inward investment to the UK and Scotland?

The UK has consistently been one of the world’s top recipient countries of inward investment. According to data from both the OECD and EY’s Global Investment Monitor, the UK has been the largest recipient of inward  investment in the EU since the establishment of the single market in 1993.

In fact, there are a number of different sources of data on inward investment globally, and a number of different ways of measuring inward investment. But all major independent sources confirm the UK as the Number One destination in Europe for FDI in 2014 across the three main measures of success: the number of inward investment projects; the financial value  of these projects; and the value of accumulated stock of inward investment.

Scotland is the most successful UK region outside of London at attracting inward investment. Between 2005-14, inward investment generated 37,000 jobs in Scotland according to EY’s Global Investment Monitor; more than in any region outside London. Data provided to us by Scottish Development International (SDI), Scotland’s inward investment agency, indicates that Scotland received some 208 inward investment projects between March 2014 and March 2016. These projects created or safeguarded 17,000 jobs and secured £10 billion of investment.

Business services and IT accounted for a large proportion of these projects and jobs created. But the majority of the capital investment was accounted for by investments in the energy sector – both the renewable energy sector and oil and gas. And around 2,600 jobs were created in manufacturing as a result  of inward investment.

The US has consistently been the top source country for investment into Scotland, both in terms of the number of projects and jobs created. In recent years Norway has also been a major investor in Scotland, particularly in the energy sector. Inward investment from France, Germany and the Netherlands has created almost 2,000 jobs in Scotland in the past two years. Scotland has also attracted investment from Ireland, Australia and Canada, but recently has had little success in attracting investment from emerging markets such as China and India, which have invested heavily in other parts of the UK.

How important is EU membership in generating inward investment for the UK and for Scotland?

What makes the UK so successful in attracting inward investment? Some of its advantages have little to do with the EU. That English is the language of international commerce is clearly an advantage. The UK’s legal and regulatory system makes it relatively easy for foreign investors to own or start-up businesses. The UK has relatively well developed capital markets, making it easier for businesses to raise funding. And perhaps too the UK’s relatively flexible employment law is also an attraction to inward investors.

But the UK’s membership of the EU single market is another big advantage. Many firms investing in the UK from outside the EU are seeking a European base from which to distribute products without the barriers they face when conducting trade from their home markets. Membership of the EU single market effectively expands the size of the UK market.

Some evidence for the importance of EU membership on levels of inward investment to the UK can be drawn from surveys. EY’s 2015  ‘UK  attractiveness survey‘ suggests that around 72% of investors consider access to the European single market as important to the UK’s attractiveness as a destination for foreign direct investment. fDi Markets, the Financial Times’ database of inward investment projects suggests that around 2,500 of 11,500 inward investment projects to the UK since 2003 specified Europe (or a particular part of Europe) as being the end-market for their investment.

There is anecdotal evidence as well. For example, the Secretary General of the Indian Chambers of Commerce was quoted in the Financial Times as  saying that ‘Indian companies viewed the UK as a gateway to the EU market and thus Brexit “would create considerable uncertainty for Indian businesses engaged with the UK and would possibly have an adverse impact on investment and movement of professionals to the UK”’.

But quantifying the precise effect of EU membership on inward investment in the UK is difficult. Some studies have found evidence that the establishment of a common market in the EU had attracted inward investment from the US to the UK that might otherwise have been located in other European countries. But other studies have found more difficulty in estimating the magnitude of this ‘EU effect’ on inward investment to the UK.

For Scotland specifically, we have no data on the importance of EU membership in influencing the attraction of inward investment. Of the 208 inward investment projects in Scotland between 2014-2016, 47 provided information to SDI on their motivations for investing in  Scotland. While  a large number of these mention the importance of proximity to markets and customers generally, none mention Europe or EU membership specifically (workforce skills and domestic market growth potential are also seen as important factors in influencing the decision to invest).

What might be the effects of Brexit on inward investment to Scotland?

The impact of Brexit on inward investment to Scotland will depend in part on what sort of trade deal the UK Government manages to negotiate with the EU. Many people have argued that Brexit is unlikely to result in the sudden imposition of new tariffs on exports from the UK, and thus Britain’s attractiveness for companies targeting the EU market will not be dented.

This is probably true to an extent. In the longer term however, it would be in Britain’s (and Scotland’s) interest to push for further reductions in the barriers to trade with the EU, particularly in services, which has accounted for a large proportion of inward investment in Scotland in recent years. But outside the EU it would clearly be difficult, if not impossible, for the UK to  push forward these negotiations.

Brexit might also diminish the attractiveness of the UK and Scotland for inward investment in other ways too. Inward investing firms rely on an adequate supply of skilled labour. Around 100,000 EU nationals are now employed in Scotland, equating to 4% of all those employed. Some sectors, especially food and drink and tourism, are particularly reliant on EU migrants as a source of labour. If Brexit were to lead to a reduced labour supply from  EU nationals, this may diminish the attractiveness of Scotland as a location for inward investment, regardless of the final destination of any output.

The argument made by some Brexit supporters that Brexit would enable the UK to negotiate more favourable trade terms with non-EU countries  seems fairly optimistic. Such deals would have to be negotiated on a case-by- case basis, and there are few examples of countries making bilateral trade deals of anything like the scope that EU member states share. Furthermore, following Brexit the UK would not inherit the EU’s existing bilateral trade deals with non-EU states, so it would have to start from scratch. It therefore seems unlikely that any such trade reorientation would stimulate sufficient additional inward investment to compensate for that lost as a result of Brexit.

Might any existing inward investment projects in Scotland be at risk as a result of Brexit?

One argument is that manufacturing activities are relatively easier to relocate than service activities. Manufacturing is capital intensive, and machinery can be moved relatively easily across borders. A trained workforce in a service industry however might be more difficult to relocate. This argument is undoubtedly too simplistic. But in recent years, much of the employment created by inward investment to Scotland has been in business services and IT (heavily reliant on a skilled workforce), while most of  the capital investment has been in the renewable energy and offshore energy sectors (where Scotland’s geographic advantages will not be undermined by Brexit).

Concluding points

Inward investment has been one of Scotland’s economic success stories in recent years. The potential effect of Brexit on levels  of  inward  investment  to Scotland is highly  uncertain  for  at  least  two  reasons.  We don’t really have a very clear idea  how  important  Britain’s  EU  membership  is  in  influencing  existing levels of  inward  investment  to  Scotland.  And  we  don’t  know  exactly what sort of deal the UK Government would be able to negotiate with the EU (on the movement of goods, services and people) following Brexit.

But it seems hard to dispute that EU membership is a part of what makes Scotland attractive to inward investment. Brexit would almost certainly lead to a temporary slowing of inward investment flows to Scotland, as the UK’s position with the EU (and perhaps Scotland’s position with the UK) are renegotiated. If the UK was able to negotiate favourable trade terms with the EU then Brexit might not have a major impact. But outside the EU, it would be much harder for the UK Government to influence the terms under  which  future trade negotiations are taken forward.

David Eiser is Research Fellow in Economics at the University of Stirling.


Read the e-book: Britain’s Decision - Facts and Impartial Analysis for the EU referendum on 23 June 2016


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