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Foreign Investment Could Dry Up After Brexit Warns Economics Professor

brexit british pound

The UK has long been a favoured destination for foreign investment but is that all about to change now the UK is leaving the EU, and given a large portion of investment comes from Europe, isn't the UK 'cutting off the hand that feeds it'?

One of the fears of the UK leaving the EU and going solo is that foreign investment will dry up.

After all, who will want to invest in a country which has lost access to one of the largest free-trade zones in the world?

And won't outside investors prefer a country with a seat at the European table, rather than one which has voluntarily stepped outside the conference room?

These are very real fears which could impact on the UK economy, according to University of Warwick Business School Professor Nigel Driffield and Dr. Erika Kispeter of the University's Institute of Employment, who recently co-authored a paper on the subject called "Job loss and job creation: pitfalls and opportunities."

In their paper, they make recommendations about what the government should do to keep foreign investment flowing in, and the foster growth through a sustainable labour market model.

Destination UK

The UK has historically had extremely high inward investment, known in Economic jargon as "Foreign Direct Investment" or FDI.

In 1970, for example, it had the second largest FDI in the world, behind only the US, and the trend has not altered overly since - except other countries have caught up a bit.

Within the G7, the UK still has the highest level of FDI  as a percentage of GDP, amounting to 64% in 2014.

Interestingly, the largest portion of FDI comes from Europe, suggesting that by leaving the EU, the UK is 'cutting off the hand that feeds it' from an FDI perspective.

FDI brings a lot of benefits to the UK economy:

"Inward investment is of vital importance to the UK economy and creates significant job opportunities, often in areas of high unemployment, which are multiplied by supply chain activity," says Professor Driffield.

Further benefits are as follows:

"Inward investors have some 40 per cent higher productivity and pay some 20 per cent higher wages than the average for UK firms - this difference has been stable for some thirty years."

Despite all its benefits, there are very real concerns that by leaving the EU, the UK could be putting in jeopardy this great source of affluence.

Driffield says there are two main drivers for outsiders investing in the UK: the first is to gain a foothold into Europe, which he categorises as 'market seeking' and the second is to achieve greater efficiency, perhaps by being close to producers of key component manufacturers, and this second reason is called 'efficiency seeking'.

Clearly, these two key drivers of inward investment could be negatively impacted by a Brexit.

A 'hard Brexit' in which tarde tariffs are imposed on imports and exports to Europe would severely impact on the attractiveness of the UK as a place to be based for access to Europe.

Regardless of the extra tariff cost, there would also be a substantial increase in paperwork associated with trading with the European Union which would make operations less efficient.

The investment from Europe into the UK, would also almost certainly suffer, due to the loss of membership of the EU.

Driffield, stresses, therefore that it is absolutely imperative that the UK negotiates a good trade deal with the EU before Brexit.

"Above all, the Government needs to avoid a hard Brexit that sees tariff barriers returning, and secure a trade deal that prioritises access to the single market for as many sectors as possible, as soon as possible," he says.

Indeed, his point is proven by the fact that Japanese car makers have warned they will curtail operations in the Uk if there is a 'hard' Brexit:

"Japanese investors have been keen to stress that future investment in the UK depends on tariff-free and barrier-free trade with the EU that is as uncomplicated and predictable as possible.

"Nissan has commented that it will review its decision to build the next generation of one of its car models in the UK when the form of Brexit is clearer. Most recently, Honda has warned MPs of the consequences of leaving the customs union," says Driffield.

Impact on Sterling

A hard Brexit would almost certainly lead to another large devaluation in Sterling in a large part because of fears of a fall in FDI, which is a major source of demand for the currency.

But far from encouraging foreign investment as some have argued, Driffield says that a weak Pound will reduce FDI flows due to fears of "lower returns."

FDI and the Labour Market

As we have already noted FDI is a great source of employment.

The government will want to keep it that way so it is not unreasonable to expect it to endeavor to keep labour laws flexible and attractive to prospective employers, encouraging the current trend for looser contractual obligations and greater provision of part-time, flexi-time and zero-hour contract status employees.

Driffield says that ideally, the government should try to strike a balance between creating the conditions for attracting FDI and ensuring employees are not exploited.

One suggestion in which the government can meet the needs of investors and employees alike is to incentivise high-quality FDI which creates higher paid, higher skilled jobs. 

Higher skilled work tends to come from sectors, such as technology, which also tends to support the general economy and help boost economic growth for the whole country.

One of Driffield recommendations is to focus on the quality of FDI, not just quantity.

"When selecting key sectors for inward investment, focus on good-quality job creation. For example, ‘high value-added’ FDI adds significantly to the underlying technological base of the economy and typically creates fewer yet higher-skilled jobs. FDI that generates large-scale employment is typically associated with less cutting-edge technology and a lower skill base.

Another of the report's recommendations is to avoid the development of intra-competition between regions in the UK for FDI tended to be the case pre-EU membership in 1972.

Intra-competitive practices between regions can be detrimental, according to Driffield, as FDI needs to be targeted to the right region, where it is most needed and fits best- and thoughtful husbandry is required in the allocation of resources - rather than fierce inter-regional competition.

Other recommendations the paper makes is to focus FDI on sectors which are not exposed to trade with the EU and also to encourage knowledge-sharing between foreign investors and local firms.

Other Drivers of FDI?

Whilst loss of access to the EU is clearly a major concern for foreign investors and will undoubtedly reduce FDI, it is not the only driver for inflows.

The UK has a relatively high skills base which also makes its attractive to foreign investors looking to recruit appropriately-skilled staff, and while this may be partly due to talent from the EU (we don't know the difference at the moment), one would assume their rights will be protected and so there will not be an enforced brian-drain back into EU after Brexit. 

Previously it was always argued that UK workers were some of the most hardworking in the world and that was why Nissan chose Sunderland for their factory, and yet whilst this might be true, it does not seem to be filtering through into greater productivity.

UK workers are less productive in general than most other workers in G7 countries.

A report on productivity by the Office of National Statistics showed, "Output per hour in the UK was 18 percentage points below the average for the rest of the major G7 advanced economies in 2014, the widest productivity gap since comparable estimates began in 1991. On an output per worker basis, UK productivity was 19 percentage points below the average for the rest of the G7 in 2014."